As you may, or may not, know, inflation is currently accelerating in Russia, as indeed it is across a large part of Eastern Europe and Central Asia. Regular readers of this blog will know something of the precarious situation which exists in the Baltic States (Latvia, Estonia, Lithuania, a fuller summary of some of the issues arising here can be found in this post). Some, like the Economist, would more or less dismiss the Baltic phenomenon, since the Baltics are, at the end of the day, "pipsqueaks". But Russia is no pipsqueak, and should Russia be falling victim to some variant or other of the "Baltic syndrome" then this will be no laughing matter (could this be a case of the Baltics sneezing and the global economy catching a cold?). Unfortunately the early warning signs are that it may well be.
The argument I will present is that the sudden acceleration in inflation which we are now witnessing across a whole swathe of emerging economies in Eastern and Central Europe is not simply accidental, or coincidental. Nor is it a simple by-product of collective poor institutional quality, bad government and/or endemic corruption. Of course there is no shortage of all of these, and in varying measure, but there are larger, and in historical terms grander, "big picture" processes at work here, and what is so striking about these countries is that no matter the differences in their policy and institutional mix, under the right circumstances they all go shooting off in the same direction. So what is happening?
Well it seems to be the case that this sudden acceleration in growth and inflation is intimately related to the very specific and unusual demographic profile which most of Eastern Europe has inherited from its recent past. So one of my central arguments is that what we have here is certain a kind of mis-match. A mis-match between a basically third world. "developing-country-type" income level (for this reason they tend to be called "emerging economies") and a very-first-world-type age structure - in the sense that many of these societies have had below replacement fertility for several decades now, and that the key 25 to 49 age group is now peaking nearly everywhere as a proportion of the total population. Before going further, perhaps I should make one thing clear. The cryptic reference to the standard Econ 101 definition of inflation that I make in the title to this post has nothing directly to do with the concentration of wealth and power which is to be found in today's Russia. It is rather a reference to Russia's ongoing population decline, and the way in which the Russian workforce is steadily contracting. Two charts essentially tell it all. (Please click on thumbnails for better viewing).
What we should all be able to see at a glance here is that over the next few years Russia is almost certainly going to face a serious crisis in its labor markets (indeed arguably, as we will see below) this is already happening. According to data from the Russian Health and Social Development Ministry, between now and 2010, the country's workforce is likely to fall by almost 9 million (assuming participation rates remain unchanged, for which see below), from the presnt 74.5 million to the reduced figure of 65.5 million.
This scenario sounds becomes even more preoccupying when we begin to think about the fact that Russia is already losing over 700,000 working-age people every year, due to a lethal combination of high mortality and low birth rates. The low fertility level which currently exists in Russsia is almost normal and commonplace among the ECA (Europe and Central Asia) countries but the high levels of adult mortality at relatively young ages are more or less unique to Ukraine and the CIS, and the persistence of this phenomenon raises a number of very important questions, only some of which are economic ones.
Apart from being in absolute decline Russia’s labor force is also aging rapidly. Russia’s working-age population is shifting from the younger age groups (15-39 years) to the older ones (40-64 years). Of the looming 11 million decline in Russia's working-age population, over 95 percent of the decrease will come from a decline in the 15-39 age group while less than 5 percent will come from a reduction in 40-64 age group. Of particular importance is the fact that the 25 to 49 age group has now finally peaked, since this age group is of special importance for economic growth for a whole series of reasons.
And the problem only gets worse when we begin to think about the low relatively level of labor mobility and labor flexibility which exists in Russia, the relatively low-level work ethic which characterizes social values in some parts of the country, and the poor quality provision which is on offer in much of the vocational and training system. The labor market development plan for 2007-10, presented recently by Health and Social Development Minister Mikhail Zurabov, is supposed to be an attempt to begin the work of addressing the huge challenge that the situation represents, but even given the best of intentions and an ability to act decisively (both of which are should not by any means be automatically assumed to be present in the world of contemporary Russia), the plan, giving it the very best possible benefit of the doubt, can only be described as a declaration of intent, and meanwhile Russia's labor market problems remain, surviving from one day to the next in what could only be described as a state of organized chaos.
Yet despite it all Mother Russia trundles on, and the economic performance has been and remains robust. Having grown by 7.9 percent (year on year) in the first half of 2007 (as compared with 6.7% y-o-y in H1 2006), Russia is more than likely to post full-year GDP growth of over 7 percent in 2007 (see chart here) despite some recent slowing down (of which more below). This growth in output continues to be driven - following a pattern which we are observing across central and eastern Europe - by buoyant household consumption and booming construction activity. Domestic consumption in fact increased by 9.8 percent in the first half of 2007, contributing in the process about 6.7 percentage point to the half yearly GDP growth.
However export growth has weakened during 2007 (see charts here) and the recent emergence of a negative contribution of net exports to GDP growth is important, and is largely explained by rapid acceleration of imports and Russia's weak non-energy export performance which have meant that the size of the trade surplus has been steadily declining (again see the chart, and remember that the data here are in "nominal" - money - terms, thus the decline in the real value of the surplus is more significant than it appears). Booming domestic demand has been fueling import growth, while the real appreciation of the exchange rate and rising labour costs far beyond the levels of productivity increases have been eroding competitiveness in most tradable sectors in manufacturing (outside resources and metals) in so doing raising the question of just how sustainable that Russian trade surplus actually will prove to be in the mid term.
In fact the latest Rosstat estimates indicate that industrial growth, and in particularly, manufacturing growth, slowed in the third quarter of this year (see chart here). Meanwhile those sectors servicing the domestic market (such as construction and the retail trade) continue to boom. The highest rates of output growth were reported in construction (23.5 percent) and the retail trade (15 percent, see this chart here for a summary of recent retail sales in Russia) The rate of aggregate output growth of the base industries and sectors (often used as a proxy for GDP growth) amounted to 8.6 percent in the first nine months of 2007 compared to only 5.7 percent in the corresponding period of 2006.
Thus the Russian economy may now be considered (after years of taking up outstanding capacity slack, see more below) to be running at a rate which is close to its potential growth capacity, benefiting in part from high energy prices and in part from large capital inflows. In this situation Russia faces two big challenges: inflationary pressures and managing an overly rapid appreciation of the exchange rate. Both of these represent serious problems in the Russian case since they are liable to reinforce the steady turn-around in the trade balance and expose a Russian economy which is dependent on an inward flow of funds to the vagaries of world energy prices and the risk appetite of overseas investors.
As can be seen in this chart here, the value of the rouble has been rising slowly but steadily over the last couple of years, the big problem which could face the Russian authorities would be if any move they made to ease currency management procedures currently in place were to lead to a large and rapid appreciation in the rouble, and if this were then to be associated with an equally sudden inward surge of funds, funds which would in all probability generate a further surge in domestic demand, domestic demand which, given the critical state of Russia's workforce and labour market, could not be met internally: hence my cryptic adaptation of the standard inflation definition in the title of this post, since what we would actually have would be too much money chasing too few people.
Inflation Push or Supply Restraint?
Apart from the sudden inward surge of funds which we have witnessed in the second half of 2007 (see below) the most notable monetary development we have seen in 2007 has been that other surge, the inflation one. This is a process we are all by now more or less familiar with outside and beyond Russia, since we have also been witnessing a steady acceleration across much of the EU10 as a region, and, of course, the latest eurostat data for the eurozone expected sometime this week is likely to show a far from "targeted" 3% or so.
At one point Russian inflation did seem to have been coming gradually under control, and remained this way into the first quarter of 2007. Since then, however, it has steadily been gaining and sustaining momentum (see chart here), and the problem has only deteriorated with each new monthly reading as the year has advanced. In fact inflation reached a cumulative total of 9.3 percent over the first ten months of 2007, with the rate accelerating to 10.8 percent in October, the highest level recorded since February 2006. This was up from the 9.4 percent registered in September and a month on month increase of 1.6 percent.
The Russian authorities now appear to be resigned to the idea that by year's end inflation will be running around around 11 percent (Dec-on-Dec) as compared to 9 percent for Dec-on-Dec registered in 2006. And this inflation is, of course, moving on down the line and entering industrial producer prices, and this rise in manufacturing costs is, in turn, the key factor in turning round Russia's trade surplus (see the Producer Price Index chart here).
A Manufacturing Slowdown and a Wage Surge?
At first sight the downward trend we are currently observing in Russian manufacturing growth - at at time when domestic demand and construction are accelerating - seems strange. The most probable explanation is that the slowdown is associated with challenges to Russia's tradeable sectors (outside resources and metals). Those parts of the manufacturing sector that service domestic demand and encounter limited competition from imports should, after all, be able to continue to thrive in the midst of Russia’s booming domestic market. But the ongoing appreciation of the ruble and the tightening we are seeing in the Russian labour market (as workers, for one reason or another, disappear from the workforce) are evidently serving to drive up unit labor costs, in a way which suggests that wages are growing much more rapidly than productivity. And without commensurate increases in productivity, real ruble appreciation and large wage rises make achieving export competitiveness in manufacturing sectors (outside resource-extraction and metals) an ever more challenging process.
According to Rosstat, average real wages and disposable income increased by 16.2 and 12.9 percent, respectively during the first nine months of the year (see charts here). Increases in real wages continue to be well above the GDP growth rate - and surely the productivity growth rate - in most sectors of the economy. Almost all sectors of the economy are now reporting increases in nominal wages well above 20 percent across 2007. The average monthly dollar wage has been steadily increasing over the years (see chart mentioned above) and increased to 497 dollars (or by 31 percent over the same period in 2006) in the first nine months of 2007 as the rouble continued to appreciate against the US dollar. Current trends suggest that the average monthly dollar wage may exceed USD 520 by the end of this year.
A comparatively warm winter last year, an increasing demand for labor in the principal economic sectors and a declining working-age population have all contributed to produce a significant and lasting reduction in unemployment. The average unemployment rate (using the ILO definition) fell to 6.3 percent in the first three quarters of the year, compared to an average of 7.3 percent registered during the corresponding period of 2006. By September 2007 the unemployment rate had decreased to 6 percent (see chart here).
Productivity Driven Growth?
Total factor productivity growth in Russia has been strong in recent years (averaging 5.8 percent over the 1999 - 2005 period according to World Bank calculations), and Total Factor Productivity growth has been the principal driving force behind average GDP growth. In part this surge in Russian productivity can be explained by increasing utilization of excess capacity, but this is only one part of the story, and the strong performance isalso attributable to major structural shifts in the economy with the reallocation of labor and capital from less to more productive sectors.
The World Bank calculates that efficiency gains within firms accounted for 30 percent of total manufacturing productivity growth over the period 2001-2004, while a more efficient allocation of resources across firms accounted for a further 24 percent. Firm turnover (entry of new firms and exit of obsolete ones) accounted for 46 percent of manufacturing productivity growth. The main contribution to manufacturing productivity growth came from the exit of obsolete firms, releasing resources that could be used more effectively by new or existing firms.
So even allowing for capacity utilization issues, the World Bank found that out of the overall GDP growth of 6.5 percent achieved in Russia over the 1999-2005 period, productivity gains from employed resources accounted for 4.15 percentage points (or approximately two thirds).
Russia's economic transformation has thus been accompanied by a dramatic shift of resources (both capital and labour) into previously underdeveloped services areas and sectors. At the sectoral level, the shift of labor into services has spurred higher productivity in agriculture, as result of labor shedding (but note below how a rural inflation problem can arise if the labour outflow is not accompanied by a capital inflow in a supply-side constrained economy like Russia), as well as in manufacturing. Over the 1999-2003 period labor in-particular transited away from low-productive sectors (agriculture) towards more productive sectors (services).
The Russian economy also continues to experience an investment boom - although levels of investment still remain comparatively low (for a developing economy) as a share of GDP, and investment is overly concentrated in a few sectors. Aggregate fixed capital investment grew by 21.2 percent in the first nine months of 2007 as compared with the 11.8 percent growth reported for the same period in 2006. While capital investments decelerated in September 2007 they still posted double-digit growth rates (16.1 percent, relative September 2006). Most manufacturing sectors of the economy, and especially those with higher value added, still receive a relatively low share of investment. For example, machine building received only 1.1 percent of the total fixed capital investment in the first half of 2007, while transport, communication and real estate operations accounted for over 35 percent of the total. This is a picture that anyone following in detail the evolution of the EU10 economies (or Ukraine for that matter) should now be pretty much familiar with.
Foreign investment surged during the first half of 2007, reaching 5 percent of GDP. The Russian central bank has estimated that inward FDI reached almost 28 billion USD during the first half of 2007 (5 percent ofGDP), 10 billion more than a year earlier.
Preliminary estimates from the Russian National Bank show FDI inflows at USD 37 billion for the first three quarters of 2007 in the non-banking sector alone. However, FDI remains concentrated in resource extraction industries and non-tradable sectors, playing only a marginal role in manufacturing. Mineral resource extraction, metals and non-tradables sectors (particularly trade) remain the favorite directions of foreign investments. Mineral resource extraction industries received USD 11.2 billion in FDI during the first half of this year (of which USD 10.7 bln. from Netherlands. To get some idea of the scale of involvement in Russia from Dutch energy companies such as, Gas Terra, Essent and Nederlandse Gasunie see this summary of the proposal for developing the Yamal peninsula and the Kara Sea that Royal Dutch Shell's Chief Executive Officer Jeroen van der Veer was recently pitching to Vladimir Putin). These resource extraction inflows amounted to 71 percent of the total FDI inflows, compared to only 33 percent in 2006. Manufacturing industries, on the other hand, received only USD 1.8 billion, or 11.1 percent of total FDI inflows in the first half of 2007, compared to 19 percent in 2006 and over 45 percent in 2005.
Unlike oil revenues, capital inflows have a different impact on the Russian economy for the simple reason that they are not absorbed by the Stabilization Fund (and thus they are not effectively sterilised). Consequently they serve to drive additional money expansion and exert upward pressure on the rouble. Given the limited monetary instruments available to the Russian authorities for sterilization (the bond market, eg, is very underdeveloped) and the current stance of monetary policy (which attempts to limit the pace of nominal exchange appreciation), reducing inflationary pressures is becoming an exceedingly difficult task.
And if we look for a moment at the components in Russia inflation (see these charts here) we will find two of our old friends stand out in the forefront - food and construction. In fact in the first 10 months of 2007 the rate of increase in construction costs was some 15% (as compared to only 9% during the equivalent period of 2006). Food price increases are evidently a global phenomenon, but the structural basis for these increases is nonetheless important. Global growth at the present time is being driven by very rapid increases in living standards in the newly developing economies (and especially in the so-called BRICs). Now one of the stylized characteristics of these economies is that the population in general tends to be comparatively poor, and as a result food consumption tends to constitute a largish share in the consumption basket (see chart for Russian CPI weightings linked above, in China and Turkey, and by way of comparison, food related products constitute around 25% of the CPI basket).
Now to some extent Russia's manpower shortages mean that supply in the agriculture sector is somewhat constrained, while, if investment totals are anything to go by, technological innovation is not notably accelerating. Investment in transport and communication, for example, constituted 23.31% of total investment in the first half of 2007, and in real estate it was 12%, while investment in agriculture only achieved some 4.7% of the total. And FDI in agriculture only constituted 0.7% of the total during the same period.
Also labour productivity in Russian agriculture only grew by 4.4% per annum over the 1999 - 2004 period (the lowest for any sector, World Bank calculations), and thus starved of its workforce, and lacking the necessary capital investment to compensate, Russian agriculture is bound to struggle to meet the needs of an ever more affluent and hungry urban population. Basically this means either continuing inflation or growing food imports, but since global food prices are themselves rising this would need to be accompanied by sustained rouble appreciation if it were to contribute to reducing the internal price pressure, and all of this would, of course, mean that Russia's ability to generate a current account surplus was called increasingly into question.
Russia's Current Account
Turning now to the current account, the Russia's surplus has has been in a process of steady and continuous structural decline on account of the rapid acceleration of imports and the relatively weak (non energy and extraction) export performance. Thus the current account surplus has declined during the first 9 months of 2007 to an estimated USD 57.1 billion (down from USD 79.1 billion in the same period of last year). Imports grew by 37.3 percent in the first three quarters of 2007 (to USD 154.6 billion) when compared to the corresponding period of 2006, while exports only grew at a modest 11 percent during the same period. As a result the trade balances shrunk by USD 17 billion to an estimated USD 94.1 billion.
Of course this weakening in Russia’s current account position in 2007 has been more than compensated for by a strengthening on the capital account side . According to preliminary estimates from the Russian National Bank, the capital account showed a net surplus of USD 59.5 billion in the first three quarters of 2007, compared to a deficit of USD 5.1 billion in the same period of 2006.
The surge in capital inflows pushed the balance of payments surplus to record highs and exerted new upward pressures on the rouble. The pace of reserve accumulation has increased further in 2007. Gross foreign reserves of the Central Bank reached USD 447 billion by the end of October 2007 (35.9 percent of GDP). Capital inflows are becoming and important source of foreign reserve accumulation, exerting upward pressures on the rouble and driving money expansion.
These large capital inflows reflect acceleration in foreign borrowing by state corporations and the banking sector (with these latter funds then being passed on in the form of domestic consumer credit to finance real estate expansion, etc). Net capital inflows to the private sector amounted to 56.8 billion in the first nine months of this year, compared to USD 26.3 billion in the same period of 2006. The banking sector has been the main recipient of these inflows (USD 37.6 billion net) most of which came during the second quarter of 2007. In a development which mirrors what we have been seeing across the whole of Central and Eastern Europe Russian commercial banks have been borrowing substantial funds abroad to finance domestic credit operations. Net capital inflows to the non-banking sector have also increased substantially during the first three quarters, amounting to USD 19.2 billion. According to the latest Balance of Payments estimates, the liabilities of the corporate and banking sector increased by almost USD 150 billion during the first nine months of 2007, out of which USD 55 billion represented short-term foreign borrowing.
This substantial external funding of the banking sector is rapidly driving up Russia’s external debt. In June 2007 external debt reached USD 385 billion. Latest estimates suggest that in October 2007 Russia experienced a net inflow of capital of about USD 10 billion. As a result, foreign reserves increased by over USD 21.6 billion reaching USD 447 billion by end October. So in the short term, of course, there is no particular issue of "defence of the rouble", it is the longer term structural implications of what is happening which we need to think about.
In the context of such large capital inflows and with limited monetary instruments available to sterilize them inflation is becoming a huge headache. As I said above, this year's strong growth in balance of payment inflows has not essentially been a by-product of higher oil prices but rather of an acceleration in inward capital inflows, and these, as I have already indicated, are not absorbed by the Stabilization Fund. The sterilization of capital inflows through general policy measures is difficult, due to the small size of the Russian bond market and limited scope for further increases in bank reserve requirements or interest rates in a liquidity-constrained financial sector.
According to the World Bank the Stabilization Fund continues to act as an effective automatic stabilizer of large inflows stemming from oil revenues, but remains ineffective in the face of the capital inflows which have become an increasingly important source of reserve accumulation and money supply expansion in 2007. One obvious policy response would be to allow a more rapid nominal appreciation of the rouble, but such an appreciation presents potential risks, and especially in the context of Russia's very tightly constrained labour supply situation, since expectations of rapid nominal appreciation could potentially attract even more capital inflows.
Another potential policy tool is the fiscal one, running ever larger fiscal surpluses in an attempt to drain domestic demand from the system, however recent revisions to the 2007 federal budget envisage not tightening but rather additional fiscal relaxation. The government submitted to the Duma earlier this year a draft amendment to the 2007 Budget Law that substantially expands public expenditures for the remainder of the year. The proposed amendments envisage an increase in non-interest expenditure of 1068 billion rubles and a rise in total expenditures to 20.35 percent of GDP, compared to the 17.5 previously approved. This development would bring the 2007 budgetary surplus down to 2.8% of GDP from a previously projected 4.8%. In an economy that is growing at close to potential, and which is driven by booming private domestic demand, additional fiscal stimulus is only going to either increase pressures for nominal appreciation (and import dependence) or produced upward pressure on the inflation level.
Coping With An Ageing and Declining Workforce
As we have seen above, rapid productivity gains were fairly easy to achieve in the first years following the crisis of the late 1990s, but the future is never an exact repeat of the past, and sustaining these rates of productivity growth will obviously now become ever more challenging. The World Bank estimates that Russian firms have now largely exhausted the post-crisis productivity gains that could be derived from bring idle capacity on-line and from labor shedding. For several years, firms were able to raise productivity quickly with little substantive investment, by drawing on the existing underemployed stock of capital and labor. However, capacity utilization rates have now risen from the 42 percent low of 1999 to almost 70 percent in 2005 (the last year included in the World Bank study). Productivity gains which far outstripped wage growth in the first years of economic recovery, are now themselves being outstripped by the rapid wage rises of the last 18 months. The real effective exchange rate has gradually returned to its pre-1990s-crisis level, and Russian firms operating in non-energy sectors are increasingly having to cope with the impact of foreign competition.
The small role of capital stock accumulation and employment growth in Russia’s growth performance (see below) contrasts with the experience of other fast-growing economies in East Asia where factor accumulation has been the main driver of output growth. In Russia, output per capita grew by 6 percent over the period 1999 to 2004 driven largely by labor productivity growth, which accounts for two-thirds of output per capita growth (4 percentage points). The low level of additional growth attributable to increased labour inputs is, of course, a by-product of Russian demographics, and this is a problem with no easy solution. But to the decline in absolute numbers and the aging of the labor force, must be added the deficiencies which are to be found in the Russian higher education system, which only serve to worsen skill mismatches, and the rigidities in labour market regulations, which make it difficult for firms to hire workers and serve to slow the pace of worker reallocation.
As we have been noting Russia's labour supply is bound to be negatively affected by its demographic trends: Russia’s working-age population will decline by 10 percent (about 11 million people) over the next two decades. This decline in working-age population is compounded by aging within the working-age population. The working age population (15 to 64 years) as share of total population is projected to decline by 3 percentage points (from 71% to 68%) by 2020. This represents a decline of 10 percent in the working age population, or about 11 million people. The projected decline in working-age population represents a source of concern, given that labor supply is a key determinant of economic growth.
But it isn't only Russia's labour supply which constitutes a difficulty, its distribution is also problematic, since Russia's labor resources tend to be highly concentrated in the centre of the country, and this is creating a serious nationwide imbalance. The outflow of labor is worst in Siberia and Russia's Far East: In January-September 2006 - according to data from the Social Development Ministry - more than 371,800 people (75 percent of them within the 15 to 65 working age range) left these regions. This "people flight" out of the far east is now a really serious problem since according to Brookings Fiona Hill - in this excellent piece of analysis - Siberia holds nearly 80 percent of Russia's total oil resources, about 85 percent of its natural gas, 80 percent of its coal, and similar quantities of precious metals and diamonds, as well as a little over 40 percent of the nation's timber resources. According to studies by geographer Michael Bradshaw and economist Peter Westin, with the exception of the city of Moscow and the industrial region of Samara in the Urals, the major contributors to the Russian economy in terms of per capita gross regional product (GRP) are all natural-resource regions, primarily Siberia and the Russian Far East. The oil-producing region of Tyumen in West Siberia tops the list; then Chukotka, also a major energy producer; Sakha (Yakutia), the site of Russia's world-class diamond industry; Magadan, a major mining region; Sakhalin, the island repository off the Pacific coast of one of Russia's richest new finds of oil and gas; and Krasnoyarsk, a vast coal mining, mineral, and precious metal producing region. So the issue of who is actually going to work in these areas in the future is in fact no mean one.
And almost 40 percent of the labor which is available in the Primorye Territory is concentrated in the city of Vladivostok, while the rural and remote areas are facing a population-blight type crisis. The Far East constitutes 30 percent of Russia's total territory, but has less than 5 percent of its population. It has substantial natural resources which could stimulate economic activity and employment, but investors are becoming increasingly reluctant to commit themselves since there is almost no one left to employ there.
The situation in the Russia's Southern Federal District, meanwhile, couldn't be more different. Here labor supply greatly exceeds demand; approximately 20 percent of the working-age population is unemployed. According to the Independent Institute of Socio-Political Studies, for example, only 36,000 people are employed in the Republic of Ingushetia (17 percent of the working-age population, as compared to the Russian average of 74 percent employment rate). Chronic unemployment continues to dog Dagestan, Ingushetia, Kabardino-Balkaria, and Karachayevo-Cherkessiya, where the share of long-term unemployed job-seekers exceeds 65 percent. In Ingushetia, unemployment amongst young people is stuck somewhere around 93 percent mark.
Of course inward migration could certainly help mitigate Russia’s projected labor shortage. Russia is already experiencing large migrant inflows, mostly from lower income CIS countries, whose working age population is still growing rapidly (such as the Central Asian countries). Migrants are also arriving from China to help ease the labour supply problem in the far East.
According to data from Russia’s Federal Border Guard Service approxiamtely 750,000 Chinese national have been legally entering and leaving Russia each year since 2002, about 80 percent of them entering through checkpoints of the Far Eastern Border District. The majority of these workers enter and leave each year, but there are an unknown number who remain behind, especially among those who did not enter the country legally.
As Yuri Andrienko and Sergei Guriev convincingly argue in their recent paper "Understanding Migration in Russia", Russia's present migration policy is extremely counterproductive as it both restricts much-needed migration and creates a constant flow of illegal immigrants. Evidently the pressure of its demographic problems mean that Russia will soon have to reconsider its present policy and it is more than likely that it will have to introduce some sort of amnesty for those currently working illegaly in the counrty in the not to distant future. The overall situation is not helped at all by the Russian government's ability to volte face and contradict itself (in the face of xenophobic pressure) on a seemingly regular basis. While attracting immigrants with the one hand, it denies them the opportunity to work with the other. The announcement by Prime Minister Mikhail Fradkov in November 2006 that as of 1 January 2007 the government would be restricting the employment of immigrants in the retail trade sector to 40% of the total was certainly not a constructive move.
However, getting hard numbers on migrant workers in Russia is not easy, and it is important to distinguish between temporary and permanent migrants. As I have already mentioned maybe 750,000 Chinese go to work in Russia on a temporary basis every year, and we know from the Russian migration service that they have just completed an agreement to allow 500,000 or so workers from Uzbekistan to go to work legally in Russia every year. The same sources accept that there are a roughly equivalent number from Tajikstan, and slightly more from both Kazakstan and Ukraine. But as Andrienko and Guriev emphasise, what Russia really needs to compensate for the demographic decline are not temporary migrants, but permanent settlers. In order to adequately compensate for this drop, there needs to be an annual inflow of about 1 million working age migrants the authors estimate, and this is three times the average net rate of inflow which occured in the years between the Censuses of 1989 and 2002. And during this earlier period, of course, we were talking about ethnic Russians returning from the old outposts of the former Soviet Union. Tjiks and Uzbeks may indeed be seen in a rather different light, as already seems to be the case on many a Moscow street.
Conclusions, Is Fertility a Dirty Word?
As we have seen throughout this extensive post developments in Russia pose acute and quite specific problems for contemporary macroeconomic theory. A declining and ageing workforce, with low accumulated levels of human capital, accompanied by rapid "catch up" growth, large external fund inflows and pressures for currency appreciation all marry together to make for an extremely combustible mixture.
The standard World-Bank-type solution (and it has to be said here that the best analysis and coverage on what is happening in Russia comes consistently from the World Bank economists, despite the shortcomings) to increase labour force participation rates among the 55 to 60 and especially the 60 to 65 age groups seems to fall far short of what is needed. Unless what we are talking about is a pythagorian-type celestial participation of communing souls it is hard to see what exactly they have in mind here, given that the physical "earthly" presence of the Russian male over 60 is rather limited at this point in time (well the Russian religion is very mystical, so maybe rather than Vladimir Putin what they need in Russia is a modern Andrei Rublev, with Andrei Tarkovsky perhaps returning from the grave to "participate" in the scenification).
As a matter of urgent priority Russia obviously needs to have a coherent immigration policy (with some strategic thinking about what exactly to do with all the Chinese nationals who are rapidly accumulating out East for example) and it also urgently needs to address the life expectancy/health problem. Longer term the whole situation though is absolutely unsustainable unless something is done to redress the fertility deficiency, but strangely all the economic reports remain silent on this topic. Why is this, I ask myself?
Of course, in order to do all these things Russia also needs to address its political problems.
Conceptually we could think of Russia being about to have a very large version of the "Baltic problem". All you need to do is make a mental switch and replace capital inflows from oil lying under the ground to those which have their origin in migrants working out of the country (remittances) in the Baltic (or Bulgarian, or Romanian, or Polish, or Ukranian) case. Both mechanisms produce a large inflows of funds, which go to work in domestic sales and construction. Since we are short of people in each case, then this surge in demand naturally squeezes up wages and then rapidly makes exports non-competitive. As a consequence the country involved becomes more and more dependent on imports.
Call this the Baltic syndrome if you will, and as I say above (plagiarizing an old adage) it is almost as if a Baltic sneeze is leading the global economy to catch a cold.
Amazingly then, we are brought to the conclusion that Russia could eventually have a trade deficit, even with all the natural resources she has in play, and at the rate we are going this point may not be too far away. What we need to bear in mind is that while global oil prices may drop back slightly (depending on whether and to what extent there is a slowdown in global growth in 2008), they are unlikely to continue to rise at the same pace as they have been (imagine a US consumer facing oil at $200 a barrel) and so since Russian oil capacity is, at best, more-or-less constant (due to depletion issues), Russia cannot continue to rely so heavily on oil exports for continuing growth (and as living standards rise oil revenues will gradually and inevitably come to consitute a declining share of GDP). And this will become doubly the case if the rouble is allowed to rise (as it must be at some point) since the rouble value all that oil revenue will then become accordingly less.