COMMENT: Russia falling into the middle-income trap

By bne IntelliNews May 22, 2013

Ivan Tchakarov of Renaissance Capital -

Russia seems to have fallen into the middle-income trap. Last year, we released "Let's play leapfrog", dated November 21, in which we argued that in 2013 Russia would reach per-capital income levels at which fast-growing economies tend to fall into the middle-income trap. A slowdown in GDP growth of a similar magnitude to that observed in other economies suffering from the same disease would yield a post-middle-income-trap average growth rate of only 1.6%, ie. exactly in line with Russia's GDP growth in the first quarter of 2013.

Are cyclical factors driving the recent economic slowdown? The Russian economy has been in a very soft spot for a number of quarters and Rosstat's announcement that first-quarter GDP grew at only 1.6% on year (the weakest performance since the fourth quarter of 2009) only served to reinforce the view that Russia's woes may be here to stay for longer than expected. Explanations abound about the underlying reasons for this rather disappointing pace of economic activity. Some argue that investment activity has failed to gather momentum, as one would have expected, in the aftermath of the 2012 political cycles. Others cite the fading real purchasing power of consumers, who have been feeling poorer in line with the rising inflation. Still others point to the bleak situation in Europe and the rather inopportune recent developments in Cyprus. If those cyclical explanations are correct, one should expect a relatively fast recovery of the Russian economy as a better global backdrop over the second half of the year bolsters confidence and encourages investment while an improved domestic harvest weighs on inflation and boosts consumers' real purchasing power.

Or is there something more pernicious at play? We offer a different, and a much less benign, structural explanation for the recent slowdown in the economy.

Economic constraints

Fast-growing economies, including Russia, eventually slow down as the easy catch-up productivity gains relative to developed economies are gradually exhausted. This is not a Russia-specific event. In the 1950s, the economist Alexander Gerschenkron observed that, in the aftermath of the World War II, Japan and Germany were able to rebuild rapidly by availing themselves of the latest technologies and industrial processes - the so-called advantages of backwardness. However, even if fast-growing economies enjoy these advantages for a relatively long time, they eventually come up against significant economic constraints, find themselves posting lower rates of economic expansion and become stuck in the so-called middle-income trap. We suggest that this is exactly what is going on in Russia right now.

Growth slowdowns associated with the middle-income trap happen at around $16,000 in constant prices. What is fascinating about the issue of the middle-income trap is that recent academic research by the National Bureau of Economic Research suggests that fast-growing economies appear to start facing this middle-income trap when their per-capita GDP levels reach around $16,000 in constant 2005 international prices. Western European economies lost steam in the first half of the 1970s as the post-war recovery came to an end. Japan suffered a similar fate at around the same income levels, although it experienced relatively faster growth than other similarly rich countries until the early 1990s. South Korea hit the constraint in 1995, before seeing the Asian crisis devastate its economy in 1997. One can add to the list the experience of countries such as Singapore and Hong Kong in the early 1980s and Taiwan in the late 1990s, all of which saw significant drops in GDP growth rates at the $16,000 per-capita GDP level.

Russia is hitting the margin this year. We estimate that Russia will reach $16,016 in 2013. Russia is not only hitting the crucial per-capita GDP threshold, but it is also in a much worse position in this respect than others in the BRIC universe. In particular, we estimate that China will hit the middle-income trap only in 2020, Brazil in 2024 and India in 2038.

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