Economic Difficulties

Economic Development, Advancements and Innovations

Lack of Competition

Competition is the driving force of any sector, sparking new innovations and lifting overall efficiency.

State-Owned Enterprises

Following the fall of the Soviet Union, many conglomerate companies were still state-owned. Under the Communist Government of the USSR, privatised businesses were practically non-existent. During the economic reforms following the dissolution of the Soviet Union, privatisation of 10,000’s of companies became a trend. The level of privatisation has been slowly rising, with the state-owned enterprise consisting of 82% of the workforce in 1990 to 31% in 2007. (see right) However, with the repeated reelection of Vladimir Putin, the private sector may be projected to shrink in the future.

Company Name2016 Sales (RUB Billions)SectorPrivate/State-Controlled
Gazprom5966gasstate-controlled
Lukoil4744oilprivate
Rosneft4134oilstate-controlled
Sberbank3059financestate-controlled
Russian Railways2133transportstate-controlled

From the table above, 4 out of the 5 top Russian companies by sales volume in 2016 were state-controlled. By state-controlled, the Russian Government either owns or holds a majority shareholding in the companies above.

This is a problem for the Russian economy, as data suggests that state-controlled companies are on average less efficient than privatised enterprises. The World Bank uses a measure named the total factor productivity (TFP). TFP is a measure of how efficiently an enterprise converts labour and capital into revenue. The TFP for state-owned companies are unanimously lower than their private counterparts in all 3 sectors as seen in the graph below, these sectors include;

  1. Agriculture and Mining
  2. Manufacturing
  3. Services
TFB of Various Sectors of Different Categories

This is predominantly due to the fact that state-controlled companies almost always decisions based on political incentives, rather than commercial incentives. As an example, Gazprom, the largest company in Russia, which is state-controlled, gave discounts to Armenia after its joining of the Eurasian Economic Union. Sberbank’s US$2.7 billion sponsorships to the Sochi Winter Olympic Games is also a prime example of political incentive, as the sponsorship is most definitely not profitable for the bank, despite the advertising and publicity.

Inefficient Private Enterprises

Overlooking the public enterprises, the Russian private sector is also non-competitive. Again, by looking at the TFP of the 3 sectors, foreign-owned companies massively outdo the domestic Russian companies, namely in Agriculture and Mining, and Services. Also, the monopoly of large companies in Russia starve the sector of innovation and competition, leading to a stagnating economy. This monopoly can be seen in the bar chart to the left, where only 1/5th and 1/4th of the economy is composed of small and medium enterprises (SMEs) in GDP and number of jobs respectively. This is anomalously low, especially when compared against the EU figures, which is 58% and 67% in GDP and jobs respectively, more than double that of their Russian Counterparts.

“Russian companies struggle to absorb new ICT technologies and to use them effectively to increase productivity and develop new business models, products, and services. Despite significant gains in infrastructure coverage and availability in recent years, Russian businesses struggle to take full advantage of ICT.” – World Bank

Trade Barriers

Russia recently joined the World Trade Organisation in 2012, significantly reducing formerly high tariffs to more appropriate levels. Despite this, the barriers to trade is Russia is still quite high. This is due to a few, but significant factors. 

First is the differing technical standards between it and other countries. While many countries globally use ISO (International Standards Organisation) standards, Russia has a self-contained set of technical standards named “GOST” (gosudarstvennyy standart/ state standard). A list of obligatory standards/certifications must be met for products to be sold in the Russian market, which other voluntary standards provides a framework for recommended minimum/maximum values for various aspects of technicalities. A central certification “organ” performs organizational operations in Russia, as stated by Russian Federal Law №184 on “Technical Regulations”.

Secondly, Russia has imposed many barriers for the import of goods into the country. Wine and dairy products from the regions of Moldova/Georgia and Belarus (respectively) were accused of having, or pertaining to have health and safety issues. Sanctions against Russia and conflicts over Ukraine also gives the government of Russia incentive to counter-sanction imports. This has lead the Russian agriculture sector to grow massively. At present, 8 trade disputes exist against Russia in the WTO. As an example, the EU argues that a “recycling fee” imposed on motor vehicles imported into Russia is a form of discriminating policy, mainly due to the fact that most domestic/Russian-made vehicles are exempt from such a fee. Russia imposes 34 barriers on imports, compared to 25 for China, 23 for Indonesia and 21 for Brazil and India. (see chart to the right)

This blockade massively throttles competition within the Russia economy, again, leading to a stagnating economy without many innovations. This is also a contribution factor to the huge difference in TFP between Russian and foreign companies.

Import-Substitution

Russia has also introduces an import-substitution program. Import substitution is the act of substituting traditional imports of goods with domestic production. This is partly in direct response to sanctions against Russia by the likes western powers such as the US and the EU/NATO. This is instead substituted with imports from the EEU (Eurasian Economic Union), an intergovernmental organisation to provide EU-style internal trade, including the free movement of people, goods and capital. This covers 19 sectors ranging from defense, car manufacturing and electronics, through the means of tax breaks and “mandatory preference” for services from Russia and/or other EEU countries. 

Import substitution is a bottom-line in the context of national safety/defense, as sanctions from the aforementioned western powers have cut off Russia’s supply of arms almost completely. However, compounded with the fall of the price of the Russian Ruble, imports have become too expensive and not viable for the average Russian citizen. Despite these, the boost in domestic production may not result in a sustainable economic gain. This is evident in the history of various latin-American countries in the 1950s.

Lack of Human Capital

Human capital is the skills, experience and knowledge possessed by an individual, or in a population in a broader perspective.

Russia has a currently shrinking population, as evident by the population pyramid. The majority of the population is of 30-34 years of age, with 4.5% and 4.4% in males and females respectively. The younger population, in this case defined as people of 14 years old or less, only account for 17.8%, 9.2% in males and 8.6% in females. This will, over time, cause the population to shrink, resulting in a smaller working labour force, which may cause a shortage in workers. A shortage of workers will not benefit the Russian economy at all, even drastically detrimental to the economy.

This is attributed to the 2 main factors of the control of the population, death and birth rates.

The death rate is a measure of the amount of people who have died in proportion to the population, usually in number of deaths per 1000 of the population. Russia has a death rate of 15 per 1000 of the population. This is much higher than the global average of 9 deaths per 1000. The low life expectancy is also a leading factor in this shrinking population. Males in Russia have a life expectancy of 67.08, while females have a life expectancy of 77.41 at birth. This is evident from the charts below, on the right is the male life expectancy, while the female life expectancy is on the left.. For reference, the global life expectancy was 72 years of age.

The low fertility rate of women also contributes to the low population. In Russia, on average, a woman will have 1.77 children in 2015 (see graph on the left), while the global average was 2.49 per woman. This is due to the use of abortion in Russia, likely attributed to the methods of birth control used in the USSR era. According to a BBC report, there were “13 terminations for every 10 live births,” a prominent factor to the exceptionally low birth rates.

Immigration, although not as prominent, is a considerable factor as to the low population of Russia. After the dissolution of the Soviet Union, small percentages of ethnic Russians in Russia have been immigrating out of Russia in hopes of seeking better economic situations. Some immigration into the country is ongoing though, mainly from ex-Soviet central Asian countries. However, these immigrants do little to help the economy, as most of them are unskilled workers.

These factors compounded causes the stagnating and shrinking population of Russia.

Education System Fails to Prepare Workers

Russia has one of the highest tertiary attainment rates in the world, at 53% of the population, while the global average is 32% according to OECD. Russian students also perform well in PISA, the Programme for International Student Assessment, comparing maths, science and reading skills. Russian students scored 1467 in the tests, higher than developed countries such as the US and Italy. This information is extracted from the charts below.

The Russian literacy is also very high, at almost all citizens being literate. Despite this, Russian employers have reported that inadequately trained workers, with 7.4% of all surveyed employers reporting such as a problem. Russian entrepreneurs say that finding adequately trained workers is one of the biggest difficulties in business. They report that the main skills that they lack are the skills to think critically, problem-solving skills and “thinking outside of the box”. These skills are usually not taught in traditional schooling, which may be a fault in the Russian education system of rote learning, rather than dynamically learnt.

Conclusion

In conclusion, these two predominant factors, population shrinks and lack of trained workers,  compounds, leading to a workforce that is less than ideal and not beneficial for the economy.

Crash in Oil Prices and Ukrainian Difficulties

During the period of time between 2014-16, Russia experienced it 5th currency crisis since the 1990s (Marek Dabrowski, Feb 2019) During the period between 2015-15, the Russian Ruble experienced a depreciation of 55% when compared against the US dollar. This was mainly attributed to the fall in oil prices, especially the large dips in 2009 and 2015 (circled in red on the image). This is evident from the GDP (US$) graph, where the two main sizable dips were in 2009, and 2015, supporting the fact that Russia’s economy is heavily dependent on oil, which is not sustainable. This single primary industry model for an economy, especially one that is the size of Russia, carries significant risks, which were realized in 2009 and 2015. 

Ukraine

Ukraine, a country bordering Russia, was recently annexed by Russia in March, 2014. Crimea was the most affected part of the annexation, and Russian-backed separatist movements were also most prominent in the regions of Donbas. This annexation caused Ukrainian authorities to lose control of approximately half of the country, including the creation of previously unrecognized regions, the Donetsk and Luhansk People’s Republics. These annexations caused numerous sanctions to be placed on Russia by the likes of US, EU, Canada, Australia Norway, Iceland, Switzerland and Japan. These sanctions were of a multi-pronged approach, split into 3 tiers, summarized in the table below.

TierNature
Tier 1Political/Diplomatic Sanctions
Tier 2Sanctions against Individuals & Entities
Tier 3Economic Sanctions
Tier 4Against Crimea

Tier 1, the sanctions against the political/diplomatic system includes but is not limited to;

  • Exclusion of Russia from the G8
  • Exclusion of Russia from the Organisation for Economic Cooperation and Development (OECD)
  • Exclusion of Russia from the International Energy Association (IEA)
  • Suspension of the twice annual Russian Summits on the subject regarding the liberalization of the border between the EU and Russia
  • Suspension of NATO-Russia cooperation
  • Suspension of voting for Russia delegates in the Parliamentary Assembly of the Council of Europe (PACE)

Tier 2, the sanctions against individuals and entities include but is not limited to;

  • The banning of visas
  • Asset freezes
    • “170 people and 44 entities are subject to an asset freeze and a travel ban because their actions undermined Ukraine’s territorial integrity, sovereignty and independence.

      The measures were introduced in March 2014. They were last extended in March 2019 until 15 September 2019.”

Tier 3, the sanctions against the economic sector of Russia is mainly concentrated on the areas of;

  • A ban on medium- and long-term financing of the largest state-owned banks and companies;
  • A ban on trade in military and dual-use equipment, and in some oil exploration and production equipment and services;
  • A ban on trade, including tourism, travel and communication services, with the annexed
    Crimea, prohibition on the use of Crimean ports and involvement in investment activity
    in this territory.
  • Source – bruegel.org

Tier 4, the sanctions against Crimea, mainly focuses on the banning of Russian shipping vessel’s use of ports.

The United States adopted CAASTA (Countering America’s Adversaries Through Sanctions Act) in April 2018. This act modified existing sanctions and introduced new sanctions against Russia (among others). Additionally, due to the accusations against Russia in modifying votes in the 2016 federal election, more sanctions were introduced against Russia. Russia counter-sanctioned countries that adoped against sanctions against Russia, namely the import of food products. Russia has also issued sanctions against Ukraine, the most significant of which, was the act of veto against the bilateral free trade agreement (FTA).

Simplified Diagrammatic Visualization of Sanctions

Economic Impacts of the Ukrainian Conflict

The impacts of such sanctions are detrimental to Russia’s economy, as seen in the graph below, the countries that have sanctioned Russia, which we will simplify as all European Countries, makes up a large percentage of Russian Imports and Exports, 53% and 51% respectively. 

To see the percentage composition in the context of continents, please press the “Continent” option under depth, in the lower left corner of each of the graphs.

These sanctions are estimated to have caused a range of 1-2% of the total GDP of Russia. (Korhonen et al, 2018) If these sanctions’ impacts are not quickly realised and fixed, the effects could be long lasting.

The clauses in Tier 4, which included the restricted access of Russian ships to ports, can have extremely large impacts on the overall economic prosperity of the Russian Federation as a whole. Russia, despite its large size and long borders, has no large ports with a direct route to sea. (The definition of a direct route in this case is the absence of any necessity to cross foreign waters) The maps below gives examples in a easier-to understand fashion.

The images are subject to copyright, and shall not be copied without prior permission. Base map provided by Google, (c) All rights reserved, Google. All other aspects and devices in the images remain the intellectual property of the copyright owners (c) All rights reserved, jy-zhang.com.

The Yellow region is Russia’s Territorial Waters

The Blue areas are Foreign Water

The Light Blue regions are international water/EEZ/etc

The Red Arrow is the most direct route to the nearest ocean

Very evidently from the maps of the 2 largest Russian seaports, access to the ocean is often at the discretion of other countries, which are predominantly hostile or at the very least, not allied with Russia. This creates complications, especially trade. Container ships are described as the backbone of international trade. While Russia does have numerous connects with Asia, Europe and Africa via road or rail, their lack of access to the ocean prevents them from trading with countries on the continent of the Americas. This is evident from the tree plots of the import and export partners of Russia above. The total import and export of both North and South America only accounts for 6.8% and 8.6% of the total trade of Russia respectively. This figure also includes large conglomerate countries such as the United States, Canada and Brazil.

In conclusion, the negative impacts of the Ukrainian conflict is very significant in the context of Russia, and should definitely not be overlooked.