Russia’s economy is facing major challenges

For instance, Russia’s GDP growth rates, net of the external situation component, were found to be zero in 2013, and may well be negative in 2014, considering the World Bank’s recent quite pessimistic forecast. The logic of breaking down GDP growth rate into components is based on analysis of the effect of global oil prices on economic growth in the short- and long-term period¹. Should in the long run growth in oil prices (and therefore increase in the net export volume) be permanent, it would mean that every price level corresponds to a specific output growth rate. Low prices force net export to decline, which also means that export volume of investment resources governing economic growth rates is low, whereas net export (and therefore the amount of money transfer to the economy) increases as prices go up, implying more investment and therefore faster GDP growth rates. Therefore, GDP growth rate is permanent when oil prices reach a certain level. This mechanism can be described through the relationship between the level of oil prices and output growth.

Temporal growth in oil prices will give rise to deviation of actual growth rate from its long-term path. In other words, temporal short-term growth in oil prices caused by growth in the aggregate demand leads to higher actual output comparing to long-term one (a supplement to permanent growth rate) as long as free capacities are available. This case refers to the effect of (growth) oil prices on (growth) the output.

At the same time, analyzing the effect of oil prices on economic growth in the long-term perspective, one should consider the permanent income hypothesis described by M. Friedman in 1957² as applied to households. The same hypothesis may be considered in analyzing the economy at large. According to the hypothesis, individuals tend to consider the first year of their income growth as temporal and therefore they save, not spend for current consumption, a considerable part of it. Should their income remains high for next several years, individuals tend to adapt to this level of income and begin to increase their consumption, in which case the saving effect subdues. In other words, Friedman argues that consumption depends on long- and mid-term income of future periods – so-called permanent income – rather than current income. If changes to income are temporal, permanent income and therefore consumption will see relatively small changes. Therefore, as indicated above, propensity to consume won’t increase much if income increases temporary.

Likewise, oil prices have an effect on GDP growth. In the long run, if price rise is one-time, GDP tends to grow unless the economy follows a new stationary path. If after that oil prices don’t grow constantly (i.e. there is no constant money transfer to the economy), GDP growth will subdue in time, because extra investment resources are needed to accelerate it. The level of oil prices is considered being similar to the saving ratio which changes in time as economic agents adapt to a new, higher level of prices.

Following the above-described logic, Russia’s economic growth rate will slow down with global oil prices, because no other sources of economic growth are currently available. Additionally, speaking of Russia’s economic growth prospects, serious adverse effects of the United States and the European Union sanctions against Russia over the Crimea issue should be taken into account.

One therefore may infer that the Russian Federation is facing an extremely difficult economic situation. Although no sweeping crisis is threatening Russia tomorrow or a week later, we think that public authorities should take into account that oil prices are likely to fall in the foreseeable future. This implies that the sole source of growth is going to disappear and recession become unavoidable, which cannot be prevented unless a sound economic policy is in place.

Maria Kazakova, Ph.D. in Economics, Head of Economic Development Department, Deputy Head of International Center for Budget Sustainability Study

1 See the following paper for more details: Анализ структурной и конъюнктурной составляющих налоговой нагрузки в российской экономике / Казакова М.В., Синельников-Мурылев С.Г., Кадочников П.А. – М.: ИЭПП, 2009. – глава 2, параграф 2.3. [Analysis of the structural and business component of tax burden in the Russian economy / Kazakova M. V., Sinelnikov-Murylev S. G., Kadochnikov P. A. – M.: IET, 2009. – Chapter 2, Paragraph 2.3 ]
2 Friedman, Milton (1957) A Theory of the Consumption Function//Princeton, NJ: Princeton University Press, chapters 2 and 3.