Russia’s potential growth rate ‘close to zero’ Premium

Shrinking labour force undermines Moscow’s ability to pull out of recession
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Russia’s potential economic growth rate may have fallen close to zero as a result of its shrinking labour force.

The country’s working-age population peaked at 90m in 2006 and has fallen by around 5m since, a rate of decline that is expected to accelerate in the coming years.

“In the next five years the number of working age people is set to decline by 1m [a year] on the back of limited labour inflows from the ‘below-working age’ cohorts as well as the increasingly large number of people reaching the official pension age of 55 years for women and 60 for men,” says Vladimir Osakovskiy, Russia and CIS economist at Bank of America Merrill Lynch.

The first chart shows the past and projected annual change (the upward blip in 2015 results from the seizure of Crimea, which is now classed as Russian by Rosstat, Moscow’s statistics agency).

Mr Osakovskiy argues that as a result, Russia’s potential growth rate has “already slowed to close to zero or even dipped into negative territory in 2016”, with any rise in total factor productivity unlikely to outweigh the reduction in the quantity of both labour and capital Russia is able to deploy, as the second chart shows.

If true, this suggests that any recovery from Russia’s two-year long recession is likely to be muted. The shrinkage of Russia’s workforce also has a number of other good and bad repercussions.

The good news is that Russia’s longest recession for 20 years has not led to a meaningful rise in unemployment that, at 5.8 per cent, is at one of the lowest levels seen in the country since independence in 1991.

Moreover, unemployment has stayed low despite a rise in the labour force participation rate, the proportion of the working-age population that is either employed or actively seeking work.

“Although total employment has been stagnating since 2007-08 and the labour force has actually declined over the period, the participation rate has been rising steadily to above 69 per cent in 2015, the highest level in the entire post-USSR history of Russia,” Mr Osakovskiy says.

While this has helped shield ordinary Russians from the full impact of the recession, it may limit the Bank of Russia’s ability to cut interest rates far below their current level of 11 per cent.

At present, the weakness of consumer demand, due to the declining labour force, is likely to be keeping inflationary pressures in check. But this could change rapidly.

Mr Osakovskiy forecasts that economic growth will edge back into positive territory in the second half of this year, before accelerating to around 1.1 per cent in 2017.

This, combined with the ongoing decline in the working-age population, means the country’s negative output gap could have disappeared by the end of next year, he believes.

“Even a technical, base effect-driven acceleration of real GDP growth to above 1.5 per cent could revive concerns about economic overheating,” Mr Osakovskiy says.

“In particular, with a very tight labour market in general, any meaningful recovery of economic growth and labour demand should quickly translate into increasingly robust nominal and real wage growth. This could start to support inflationary pressures sooner rather than later.”

Charles Robertson, global chief economist at Renaissance Capital, a Moscow-based investment bank, is a little more upbeat about Russian growth.

His starting point is that emerging market countries typically have a baseline potential growth rate of 3 per cent. With Russia’s working age population shrinking at 1.2 per cent a year, he argues that leaves potential GDP growth of 1.8 per cent a year.

He is also of the view that a fall in a country’s GDP “does not matter terribly much” to ordinary workers, as long as GDP per capita is rising, although it matters more to equity market investors (as more people and faster GDP growth should translate into faster earnings growth and higher share prices) and those who pride themselves on their country’s clout on the world stage.

Mr Robertson, points out that the phenomenon of a declining working-age population is not limited to Russia. As the third chart shows, this trend is unfolding across much of eastern Europe and parts of east Asia, with Ukraine and Bulgaria seeing faster declines still than Russia.

Russia is potentially in a tight spot however, at least in terms of its ability to raise its overall GDP growth rate.

For those countries with a declining labour force, Mr Robertson analysed their unemployment and labour force participation rates. He has concerns about those with low unemployment and high participation, as these countries have little surplus labour to be brought into play.

In this “problem corner”, are Germany, China, Estonia, Japan, Lithuania and the Czech Republic, as well as Russia, as the final chart shows (the underlying numbers are a few months out of date, but the broad picture stands).

Despite this, Mr Robertson is more relaxed about Russia’s plight than that of, say, China. Russia, with a total population of 144m (excluding Crimea) has for some time imported labour from neighbouring states such as Georgia, Armenia, Ukraine and the “Stans” of central Asia. China would need a far larger number of foreign workers to make the same impact, given its 1.4bn population.

If the Russian labour market becomes too stretched there is scope for these migrant flows to accelerate and, although many of the newcomers might be less skilled than the typical Russian, those from the likes of Georgia and Ukraine should be on a par.

Mr Robertson argues that President Vladimir Putin has gone out of his way not to demonise migrant workers, even in periods when unemployment has risen.

“I think he knows that Russia needs that labour force. In some other countries you have politicians exploiting it, but you don’t in Russia,” he says.

Mr Osakovskiy is less convinced arguing that although the flow of migrant labour has slowed, Russia already has the second largest foreign workforce in the world, after the US, limiting the scope for it to rise higher.

“There is a significant labour shortage here domestically. It’s hard to reverse that,” he says.

One other option would be to increase the Russian labour force by raising the retirement age. Given that male life expectancy is only 63 there would appear to limited scope to raise the male pension age of 60.

However, given that women, with a life expectancy of 75 and a pension age of just 55, typically enjoy a retirement 17 years longer than that of the average man, this would seem to be an obvious anomaly to be addressed.

Mr Osakovskiy agrees pension reform is called for, but argues this is a slow process, with pension ages rarely being raised by more than six months a year, as in neighbouring Belarus.

Mr Robertson is not averse to a higher retirement age, but argues this would do nothing to make the Russian labour force more dynamic or entrepreneurial.

Quoting figures suggesting the number of 16-24 year-olds in Russia is likely to decline from 12m in 2010 to 7.5m by 2020, he says: “when you lose the sort of people who are playing around on iPhones, setting up apps, starting companies and being dynamic, you have a loss of renewal and innovation,” two qualities the Russian economy is desperately in need of.

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