The Effect of Each Cause on the Russian Gross Domestic Product - Essay Example

The Gross Domestic Product (GDP) of Russia Introduction The Russian economy is an interesting example of the progression of an erstwhile socialist nation towards market economy. The Russian economy provides a counterpoint to the Chinese economy where the capitalism is allowed to develop within a framework of a socialist economy. In Russia, the entire economic framework was dismantled and the private players were expected to provide a new framework with little or no support from the state. The economy spiraled into a crisis in the 1990s with a recovery since the late nineties. This paper will examine the GDP of Russia as an indicator and track the changes in the Russian GDP from 1998 to 2006. The paper will examine the various causes of the change in the GDP during this period. The effect of each cause on the Russian GDP will be examined both individually and collectively. The feasibility of developing a mechanism to test whether the identified factors are indeed critical will be examined in detail. The economic policy of the Russian government with special relevance to property rights, taxation, regulations regarding the entry of private players in various sectors including sectors like energy (which is a crucial aspect of the Russian national infrastructure) is also a crucial to the study of the Russian GDP level over the past decade. The establishment of a macroeconomic structure, the reform agenda of the government and its implementation by the Duma, the oil prices in the international market, the value of the Russian rouble during the period of the study is the other aspects which will have a bearing on the study (Korhonen 1998). Components of the GDP We will cover the various sectors contributing to the Russian GDP in the next section, in this section; we will analyze the various types of expenditures which contribute to the GDP. The domestic consumption or the private consumption includes the expenditure incurred by a family on a recurring basis like food, rent, medicinal expenses etc. This is difficult to quantify (McKinsey Global Institute 1999). Next component is Capital investment, the hallmark of capital investment is that money is exchanged for either goods or services; another important hallmark is that after the exchange, there is no liability on the provider of the goods or services for repayment at a later stage (McKinsey Global Institute 1999). After having quantified the domestic and the private sector, it is essential to quantify the expenditure incurred by the government. As a rule it includes the salaries paid to the government servants and the expenses incurred by the government towards the infrastructure establishment. An important aspect to be borne in mind while estimating the GDP is that all expenditure which does not translate either into physical goods or services provided is not included into the GDP. This includes savings in banks, mutual funds, investments in stock markets etc (McKinsey Global Institute 1999). The final type of expenditure is the net exports. This is the net difference between the exports and imports of the country (World Bank 2002). The above model attempts to estimate GDP based on the expenditures, we can attempt to quantify the GDP based on the income generated by the economy. In this model, the various parameters of importance are the Gross Operating Surplus (GOS) calculated from the gross profits of the incorporated businesses, the Gross Mixed Income (GMI) which measures the gross profits of the various unincorporated businesses and finally the Compensation of Employees (COE) which measures the total compensation paid to all the workers in both the public and the private sectors. This sector also includes the contributions of the employers to the various social security schemes on behalf of their employees. The total of all these factors is an approximation of the total GDP quantified on the basis of the income model (World Bank 2002). Estimation of various Parameters of the Russian GDP It is important to establish the various parameters by which the GDP of Russia will be quantified. The GDP of Russia is quantified by the Federal Service of State Statistics (World Bank 2002). This government agency publishes a monthly report on the country's GDP based on various economic parameters. The GDP assessment is based on the production of the varied figures which constitute its economy. The sectors accounting for the bulk of Russia's domestic product are agriculture, trade, construction, exports, industrial production and services like Information Technology, expenditure on consumer goods. It is essential that we identify the indicators for each of these sectors which will be used to quantify its contribution towards Russia's GDP (World Bank 2002). The contribution of the agricultural and the industrial sectors are quantified accurately due to the centralized distribution processes for both these sectors which are remnants of the country's socialist past. For the rest of the sectors, a variety of sub factors will be used to arrive at the quantifiable contribution of each sector. For example in the transportation sector, an accurate representation of its contribution can be obtained from combining various figures like, the total volume of freight transported, the total distance clocked by freight transport, the number of passengers, distances traveled by passenger transports, the revenue generated by both passenger and freight transport (McKinsey Global Institute 1999). A similar template can be used to estimate the individual contributions of each sector. The only sector which poses a difficulty is the services industry. It is difficult to model the various components of this sector due to the unavailability of comprehensive data which covers all the sub sectors of this industry. Once the individual contribution of each sector has been established, a regression analysis is carried out according to a formula determined by the Federal Service of State Statistics (McKinsey Global Institute 1999). The regression coefficients in this formula correspond to the ratio of the individual contribution of that particular sector in Russia's GDP (McKinsey Global Institute 1999). The significance of regression analysis is its ability to provide a limited forecast of the trends in the country's GDP (World Bank 2002). It is estimated that the Russian GDP is of the order of $ 1.5 trillion. The per capita GDP is approximately $ 11,000 (World Bank 2002). In order to determine the main driving forces of the Russian GDP, it is essential to identify the various factors affecting them. Agriculture was severely affected by the States inability to reform the state farms apparatus. The new land code approved by the Russian parliament is expected to help in the reform of the agricultural sector. The various aspects affecting the trade component of the Russian GDP are the customs regulations of the government, the international prices of oil, natural gas, metals and wood, and finally the value of the Russian rouble (Rautava 2002, Korhonen 1998). The industrial base of Russia is basically inherited from the erstwhile USSR. Weapons and Weapon systems are the primary export of the Russian industry. Post Communist State of the Russian Economy The remarkable turnaround of the Russian economy over the last ten years can be understood in the correct perspective only if we understand the position of the Russian Economy after the collapse of the communist economy and the market crash in 1998. The early economic reforms after the collapse of communism had the twin aims of macroeconomic stabilization and the economic restructuring of the various financial institutions. Macroeconomic stabilization involves the formulation and implementation of policies which sharply reduced or eliminated various sectors which were earlier subsidized by the government. The primary aim of these policies was to reduce the budgetary deficit and contain inflation. The monetary and fiscal policies did not contain inflation and the availability of money fluctuated rapidly, this lead to the sharp decline in the quality of life of a majority of the Russians. One of the cornerstones of the economic restructuring is the privatization program. The program was implemented in two phases; the first phase involved the transfer of shares worth 10,000 roubles each to about 140 million Soviet citizens. These shares in selected companies were awarded against vouchers of 10,000 roubles. This phase included the privatization of more than 67 percent of the larger state run endeavors and over 92 percent of the smaller state run ventures. (Korhonen 1998).The next phase involved the transfer of the remaining equity held by the government in exchange for cash. This phase was however marred by several allegations of corruptions and could not muster sufficient legislative support in the Duma or the Russian parliament. Finally it was implemented in 1994 by Presidential decree. By 1996, the Russian economy was in the grips of a severe depression. The Russian GDP was reduced by more than 50 %. This is the worst fall in GDP sustained by a modern industrialized nation in recent economic history. The industrial sector recorded a severe drop in production primarily due to severe imbalances in the prices of their raw materials. Another cause for concern was the distorted geographical distribution of the country's wealth. Most of the foreign investments were in the Moscow region and neglected the other rural parts of the country. We have seen that oil, natural gas and metals form the predominant exports of Russia (Rautava 2002). The Asian crisis hit the prices of these commodities causing them to fall sharply. This caused a severe economic imbalance leading to severe repercussions for the Russian economy. The depression in 1998 caused a sharp fall in the exchange rate of the rouble, the government defaulted on its debt repayments, the banking sector was severely hit resulting in the failure of several institutions and finally inflation reached astronomical proportions leading to large scale increases in the prices of essential commodities (Korhonen 1998). The international financial institutions put together an bail out package which involved an immediate inflow of liquidity as an interim measure. One more feature was the exchange of short term rouble treasury credit notes with long term euro bonds. These steps did not restore the failing economy and in late 1998, the government announced drastic steps, the most notable of which was a sharp devaluation of the rouble and the restructuring of the public debt (Korhonen 1998). The implications of the economic crisis was not confined to Russia alone but was felt across the entire financial world. The Remarkable Recovery of the Russian Economy After the financial crisis of 1998, the Russian economy scripted a remarkable economic recovery. In the previous section we have examined the state of the Russian economy after crash of 1998. The present economic state of the country will demonstrate the progress made by Russia on the Economic front. The GDP of the Russian state is $1.5 trillion, the ninth largest in the world (World Bank 2002). It is believed that the inherent statistical inaccuracies are responsible for devaluing the Russian GDP by 30 %. The government agency, Federal Service of State Statistics, has not considered the various new business enterprises of the emerging economy. Due to the continued high prices of crude oil and metals in the commodities markets over the last decade, Russia has consistently registered a trade surplus ((Rautava 2002). In 2005, the trade surplus was $140 billion, an increase of almost 27 % from 2004. A remarkable feature of the Russian economy is the stabilization fund created by the Russian government. The main aim of this stabilization fund is the insulation of the Russian economy from the volatility of the international oil market ((Rautava 2002). This fund is set to approach $150 billion by late 2007 (World Bank 2002). The banking system however is an area of concern. Another key role of the stabilization fund is to prevent the appreciation of the rouble. Russia has made a consistent attempt to reduce its foreign debt. The foreign debt now stands at $ 2 billion (as on 01 Jan 2007) as opposed to $ 23.5 billion, six months ago (Korhonen 1998). It is essential to accurately determine the impact of various sectors on the Russian GDP. The most important component of the GDP is the oil and natural gas sector. It constitutes over 25 % of the country's GDP and is responsible for over 50 % of the capital investment. It also forms a significant chunk of the government revenues (Rautava 2002). Before the nationalization of the Yukos and Yuganskneftegaz corporations, the government had a controlling stake in 15 % of the national crude production. The Russian government now has a controlling stake in 30 % of the national crude oil production (Rautava 2002). Further reorganization of the energy sector is also expected after the expected nationalization of the various subsidiaries of the Yukos corporations. It is evident that the price of crude oil in the international markets and the exchange rate of the rouble impact the Russian GDP considerably. This has been substantiated by various studies on the Russian economy (Korhonen 1998, Rautava 2002). Some aspects which affect the Russian oil industry and therefore the Russian economy by proxy are the high taxes imposed by the Russian government on the export of crude oil in 2005 (Rautava 2002). The ostensible purpose of this tax is to discourage the export of crude oil and encourage the refining of crude oil in Russia. Another area of concern is the appropriation of the oil profits by the Russian government once the profits approach pre determined levels. These profits are accumulated in the stabilization fund mentioned earlier in this chapter. As this fund is used exclusively to offset the fluctuations in the oil prices in the crude oil markets and the repayment of foreign debt, this surplus is not used to fund any other economic or social activity. Hence the surplus created by the oil revenue is not being used to create infrastructural assets, but to repay external debt. Demonetization of the Russian economy is also a primary cause of the economic revival of Russia. A weak rouble is ensured by the stabilization fund created from the oil reserves surplus (Rautava 2002). Global Integration of the Russian Economy It is essential that the Russian economy be recognized by the international community for the continued progress shown by it over the last decade. One of the primary indicators of international acceptance is the proclamation by both the European Union and the United States of America that Russia is a market economy. This announcement has had a favorable impact on the international perception of Russia as an investment destination. Russia's S&P credit rating has been increased to 'BB'. Several important foreign direct investments have also been announced like the $6.5 billion investment by British Petroleum in Russia's energy sector. Further global integration of the Russian economy is essential for its long term growth. Russia's inclusion into the World Trade Organization (WTO) is the next logical step. However WTO accession is a package deal and though it opens up several new markets for Russian exports, Russian economy can no longer protect its domestic industrial sectors from their international competitors. This will result in the closure of several industries that are not profitable. As in several other countries, WTO accession has both political and social implications and will require political will for the implementation of several mandatory statutes. Key Drivers of the Russian Economy and Mechanisms to Test Them Some of the key features which have emerged as the driving forces of the new Russian economy have been the energy sector, metal ores and the weak rouble (Korhonen 1998). The energy sector's contributions to the GDP, earnings of the government and foreign direct investment have already been highlighted in the earlier sections. One of the most impressive achievements of the Russian economy is that it has avoided the perils of other oil based economies by insulating its economy from the price vagaries of the international crude market by setting up a stabilization fund of approximately 8.7 % of the country's GDP (World Bank 2002). The various other uses of this stabilization fund have been discussed in the earlier section. The oil prices in the international market continue to be still high. However the rouble has been steadily appreciating, it has regained about 50 % of its value which existed before the financial crisis of 1998 (Korhonen 1998). The most apparent effects of the appreciation in the rouble is the reduced value of indigenous Russian goods, this has resulted in the inability of the Russian goods to compete with their cheaper imported equivalents without support from the government in the form of protective tax barriers which impede the WTO accession of Russia (Korhonen 1998). The prices of the metal ores have also remained consistently high in the international markets. However the prices are subject to wide fluctuations though the base prices of the metals continues to increase. The stated policy of the Russian government is to promote the refining of both crude oil and metal ores within the country as evidenced by the increased taxation on the export of raw crude oil and metal ores. Conclusion Though the Russian economy has demonstrated sustained growth over the last ten years, it still faces several challenges on its road to development. The emphasis of the Russian government to diversify its existing industrial base outside its resource base of crude oil and metal ores is an attempt to create value within the country and to discourage the export of raw materials like crude oil and metal ores. Another example of government intervention in the economy is the creation of Special Economic Zones (SEZs) at various places in the country. These SEZs have been given preferential treatment in terms of tax breaks and land allotments. The primary aim of creating these SEZs is to ensure the equitable distribution of wealth across the country. The most important sector in the Russian economy requiring immediate reforms is the financial sector. Unlike other countries' Russia's domestic savings and foreign investments are not channeled into investments. There are very few avenues for a new enterprise to raise its capital. This translates into continued dependence on the oil surplus for a variety of tasks ranging from the repayment of external debt and ensuring that the rouble does not appreciate. Urgent reforms are required in the financial sectors to allay these concerns. Russia is performing a very difficult transition from a centralized economy to free market economy. Various critical sectors of the economy like Agriculture and Industry are in the process of transformation with the government enacting property reforms and privatization programs. The biggest challenge for the Russian economy will be sticking to the reformist agenda and reducing its dependence on its energy sector. Bibliography Korhonen, Iikka 1998, "The Sustainability of Russian Fiscal Policy," Review of Economies in Transition 1/98, Bank of Finland. McKinsey Global Institute (1999), Unlocking Economic Growth in Russia. Rautava, Jouko 2002, "The role of oil prices and the real exchange rate in Russia's economy," Bank of Finland, BOFIT Discussion Papers No 3/2002. World Bank 2002, Transition - The First Ten Years, The World Bank. Joseph R. Blasi, Maya Kroumova, and Douglas Kruse 1996, Kremlin Capitalism: The Privatization of the Russian Economy Read More