Excerpt
TABLE OF CONTENTS
Abstract
Table of Abbreviations
Introduction
Literature Review
Exogenous Growth Theory
Data Source and Description
Modelling
Regression Results
Impulse Response Function
Conclusion
Appendix
Reference List
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Abstract
The initial post-soviet union period has brought Russia a longest path towards expected economic growth, much of which are explained by external factors. The paper applies the neoclassical economic growth theory to the Russia’s economy during 1990-2013, explaining the importance of foreign oil price changes, inflow of migrants and its geostrategic location towards global trading - including arm sales to notorious North Korea and Iran - to its annual output growth. I also explained the relative correlations between domestic, internal variables, such as changes in legislation/tax reformations, savings and the growth rates achieved periodically for comparative reasons. Future forecasts approved that the growth has been stabilized in a near-term and will become increasingly more depended on the number of Central Asian and other area migrant workers as long as the negative spread between birth and death rates hold in the long-term. And investment in IT industry and attracting foreign hi-tech investments are highly recommended to increase the factor productivity and lessen the oil dependency in the long term. A regression results on the Cobb-Douglas production function also proved our findings by putting more prominence on labor and technology, as the abundance of natural resources, capital, barely reaches increasing returns to scale. I also found that the regression on constant GDP to the oil production and oil prices asserted that more than two third of variations in output could be the reflection of the variations in oil prices.
Keywords: exogenous growth theory, granger causality test, impulse response function, capital formation, factor productivity, population growth
Table of Abbreviations
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Introduction
Seventy-four-year old, obstinate Soviet Union (USSR) regime has finally seen a painful, but fortunate demise, prompting 15 countries to be independent, build their own future path. Majority, although shook in the initial period, has now been achieving economic growth in many ways. Russian Federation (Russia), as the bearer of former USSR liabilities (Andrew, 2007), has seen the most prolonged plunge among the countries in transition (Daniel, 2000). Practicing so-called “shock therapy”, Yeltsin (1991-1999) achieved wider income differentials and extensive poverty at places. Evidently, Russian future was left in the dim with the severe recession and decreasing rate of growth factors, such as negative net exports. However, after the rapid depreciation of the Russian currency, ruble, back in 1998, a year before the president Putin comes to the power, positive economic indicators started to slide up. There were clear improvements in oil production, foreign direct investment (lured mostly by the low value of local currency or increasing global oil prices), labor force and internal infrastructure. Now the country, who has been performing with the negative account balance almost for a decade, gradually started increasing exports and substituting around a third of its import products with locally manufactured ones (Paul, 1999).
The push on global oil prices also accounts for a large share in Russian growth as the major export, around 80% of total exports was through the sales of natural gas and oil to China and western countries. Even the quantity decrease of oil exports in 2001 has been compensated by the increase in oil prices, giving the country more return in monetary terms. Although natural resources are widely considered the only significant source of growth (Stieglitz, 2003), Russia has done many reformations along the way, such as stabilizing and lowering taxes for individual and corporate entities, maintaining steady rate of exchange and inflation to stimulate business sectors and increase the total welfare (Arnold, 2005). By now, Russia has become ‘eighth largest by nominal value of GDP and fifth by PPP’ (CIA World Factbook, 2012) and also one of the front-runners among in-transition economies. Yet, still, what factors constitute to the stable and long-term growth has been a very concerning issue ahead of the Russian authorities and its foreign partners. Is it the endogenous variables or exogenous that play a significant role in such a ‘bonanza’? How much vulnerable could the internal economy be towards global shocks? What is being expected in the longer run? The paper intends to clarify these and such questions and provide possible explanations.
The main purpose of the research, however, is to analyze the growth-contributing factors and using exogenous theory[1] to explain and forecast the near and long-term state of the economy. And these are the appropriate research title, question and objectives to be followed throughout the research.
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Before providing the results, I will be discussing and putting some remark on Russian economic history and reference the authors who made contributory works. Impulse Response Function will be used to discover effects of macro variables. Forecasted values will be presented in the end.
Literature Review
After the Soviet Union collapse, Russia had to take extensive measure on its infrastructure. The in-time president Boris Yeltsin – partly by the advices of IMF and the US and partly by the hope of achieving the same results as Poland did once – started radical reformations towards market-based economy (Paul, 1999). Yet, the extensive privatization resulted in increased number of organized crime and ‘hostile takeovers’ (Daniel, 2000). The output level decreased almost twice till 1998, oil production fell dramatically, labor force saw a steady decline, and population growth became negative, mostly due to the worsening of Russian people’s life conditions. Russia started to borrow from outside, making the former USSR liabilities even heavier (Andrew, 2007). But that was not the only problem, many sectors were left inadequately financed. Defense industry, for instance, has seen a very dramatic decline in government subsidies. It was then when government started to increase oil production, welcome FDI inflows, it spared more monetary and strategic attention towards the industry. The intention of becoming a dominant global economic and political player was then put ahead of the nation (Arnold, 2005). With the aim of doubling total output in a decade, Putin pushed through many policies. Duma, Russian Parliament, has enacted several laws that are to protect domestic natural resources from outside ownerships. While rich in natural resources, Russia enjoyed great potential of increasing its GDP per capita over time (Barro, 2008). Life conditions, incomes of the people have doubled comparing to the level at the start. More than half of the labor force have been engaged in service sectors, industry stood next. Unemployment averaged around 5-7%, number of Small and Medium Enterprise (SMEs) increased and their role in job provision as well. Income tax is fixed around 13% and Corporate one at 24% (Arnold, 2005), reducing the tax risk that an investor might face. As a consequence of ongoing reforms, Moody’s credit rating company has updated its previous Baa2 (2005) to Baa1 (2012), which clearly lowers credit risk. And now, Russia can purchase foreign capital with less risk premium and provides a better looking platform for foreign investment. And this also reflected in the membership of Russia to World Trade Organization, increasing future prospects as a credit-worthy country. Still, Russia is considered as a developing country by the IMF, which clearly shows that there are more modifications to be made both inside the governmental system and outside - financial system as an example (Harding, 2008).
However, many of Russian foreign activities are blamed by the developed countries, such as United States of America – for selling arms to Iran and North Korea, where the risk of nuclear weapon exploitation is very high. The US constantly worries about any ‘spillover’ effects, that those nuclear weapons, even if these countries do not pose any risk to the global economy, the strategies of making or any ready one could leak to those radical groups without a proper state – which would be very devastating (CNN). Despite the criticism of the west, Russia continues either directly or indirectly help those countries to achieve their ‘dreams’ (CNN). Arm sales has increased threefold since 1990s, accounting for 7-8 billion USD in 2011. The latest increases are mainly practiced under the presidency of Medvedev. Its main partners are China, Central Asia, Belarus, North Korea, Iran, Venezuela, Syria and recently, by the visit of Lavrov, Egypt. Now, Russia stays second in the world by the value of arm exports, after the USA. Russian government, apparently, wants to keep its political and economic influence on these countries, limiting the US’s power at those places (Andrew, 2007). A very sign of this could also be noticed in the recent Russian efforts of integration with Belarus, Kazakhstan, and Uzbekistan. But the US blames unexpected Russian policy modifications as a certain risk towards partnership of any kind (CNN). Government’s takeover of energy companies have not become a forgotten past. The recent ban on a “type of bird” imports from the US has been cited rhetorically (Pravda.ru). But in fact, Russia is going to the market oriented economy [where prices will be determined by solely the demand and supply equilibriums] by taking slow measures; as the former finance minister has warned us that it could take more than a half century for Russia to be fully transferred to the market economy and integrated to the global economy, by strengthening social packages along the way. But any political and economical reforms should be carefully applied, otherwise the birth of Cold War is going to have a birth again, even if Obama asserts no.
Despite having vast amount of diamond and other mining reserves, Russia is a net energy exporter; more than 80% of total exports and a third of economic growth comprises oil and gas (see the appendix). And it is also noticeable from the graph of natural resources rent[2] (which is the net profit from natural resource sales) and Russian gross domestic product (GDP) that Russia is increasingly becoming dependent on oil and gas exports. Russian President Putin (2007-2008) calls for any possible ways to eliminate the dependency. Technological progresses and factor productivity was aimed to increase the output. State started to invest in nanotechnology and other IT industries. Even challenging foreign experts and companies to spur technological progress has been stressed.
Till now, many economists expressed their interest, by analyzing Russian growth and its growth factors. They are particularly interested in the role Russia will be playing in the long run. Russia is the big market. Raj M.Desai and Itzhak Goldberg, as an example, questioned Russian competitiveness and recommended putting more priorities on education, through which factor productivity will increase and improving internal environment for foreign and domestic investors to attract money and to keep the money in the economy respectively. Even if Russia boasts about its number of higher educated people, most of its universities do not meet the requirements, they pledge. They have claimed that much of the financial outflow has gone abroad, particularly to Gibraltar and Cyprus. However, he notes and provides proofs on the fact that these money are coming back to the Russian economy as an investment.
Charles Wolf and Thomas Lang also have researched the composition of economic growth of Russia, around 1995-2005 years. They also used regression results to find the relationship of economic growth to the natural resources and particularly expressed their interest towards external factors that can be reflected in the internal economy performance. However, their findings are rather limited for a short period, showing less dependency on natural resources (around a third comparing to my more than 80%). Unlike the work they have done on the correlations of particular export revenues to the world prices, I provided correlation between price and income, production, labor and capital.
In 2006, OECD Economic Survey has also devoted its research on Russian internal economy infrastructure, by scrutinizing the policies associated and government accounts for any possible transaction. They also endorsed, like Raj and Itzhak, the government of Russian to modify its macro policy and create a ‘high growth potential’ area. Healthcare, civil service are found to be inefficiently structured and public bureaucracy has been mentioned that should see some modifications.
In all the researches, the conclusion and factors of growth are similar, citing the increasing importance of technology and labor division, the productivity of factors as the most desirable practice to achieve higher growth. And Russia should also make modifications to its policies and stabilize its future, filling gaps in its internal infrastructure. Many projected average of 3-4% growth in the coming decade.
Exogenous Growth Theory
Exogenous growth model explains the state of the economic growth by considering capital, labor and factor productivity (technological progress, labor and capital productivity, population growth) (Solow, 1956). There are numerous key assumptions of the model. The first one is the existence of diminishing return of capital when everything else is constant. Unlike this feature, most classical economists puts forward two theories: rate of profit could be decreasing because of the competition arisen or increasing because of the productivity measures achieved in labor division (Baro, 2008). The second one is now when the only variable that is not fixed is labor, and any growth in the number of labor force will result in a slight growth for a short period, and over time comes back to its steady state, making zero changes in GDP per capita (Blanchard, 2010). Now, if the factor which can be varied is technological progress, per capita output will keep up the same pace as the IT progress (Solow, 1957). To conclude, the model specifies that in the long run the economy will come back to its steady growth rate factors on its own, even if positively affected by government policies such tax abatement or investment subsidizing in the short run.
[illustration not visible in this excerpt] - a given production function itself identifies the share elasticity of individual factors, where A is total factor of productivity, mostly known as technology innovation factor, however it also represents capital and labor productivity and other not included shocks. (Mankiw, 2000) and L and K stand for labor and capital respectively.
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[1] A.k.a. neoclassical growth model [the paper uses both terms and treats them identically]
[2] see Appendix