bne Chart -

In my recent post Russia's Crash and Recovery in Motion I included a remarkable moving chart that dramatically shows Russia's collapse in the 1990s and the speed of its recovery in the following decade. Several people have written in response raising important questions: namely, isn't this growth all about oil and the "easy growth" of catch up. The first implies that the growth will stop as soon as the oil price drops; the second that growth will stop soon anyway as all the spare industrial capacity is used up.

Before addressing these questions I made a new chart that compares Russia not with the other BRICS countries (although I left China in for reference), but a selection of other countries in emerging Europe. It's a bit confused and you have to play it a few times to see what is going on, but some interesting points come out. To remind you how the chart works: a vertical fall represents a sharp decrease in income whilst horizontal movement to the right represents increases in household spending.

The questions are tricky as I don't see a way of separating out the variables they seek, but this chart throws some light on just how big these variables are - in an intuitive way anyway.

Clearly there are three things that go into the fuel that drives the growth this chart shows: "the oil effect" (having lots of petrodollars leads to spending that results in GDP growth; "the catch up effect" (simply putting bums on empty seats in Soviet-ere factories leads to very cheap and fast growth); and "the reform effect" (making real improvements to the system results in long-term sustainable growth).

Let's look at Turkey first. As this country never belonged to the Warsaw pact but was a basket case until the beneficial effects of globalisation kicked in around 1990 we can use it as a proxy for the reform effect. The chart shows clearly that both income and spending started growing at a very steady rate from 1990 onwards. Also take a look at Georgia. This is the most progressive reformer of all the CIS countries (an organisation it left after the 2008 war), but like Turkey it has no natural resources at all. The point to note here is that after the collapse in the 1990s it grew more-or-less at the same pace as Turkey in terms of income and spending.

Poland next. Poland doesn't have any of the mineral resources many of the other countries of the former Soviet Union enjoy, but is also clearly the most successful of the former Warsaw pact countries. It was one of the few countries in the world to avoid recession following the meltdown in 2008 and we can take it as a proxy for the reform effect + catch up effect.

What is interesting about this one is that it has been growing steadily since 1991, while almost all its peers in the CIS spent that decade collapsing. The second point to note is that it grew much faster than Turkey throughout the last two decades. One assumes that its proximity to the West and accession to the EU in 2004 helped it grow, but 2004 doesn't seem to make much difference to the rate of growth in the years immediately afterwards. Also we have to assume that the early growth after 1991 was catch up growth, but as the spare capacity was used up it switched smoothly into reform growth as businesses that had made big profits using up their cheap spare capacity reinvested this money into new facilities and kept making profits.

Now looking at the CIS countries of Belarus, Ukraine and Kazakhstan, the main point to note with these is that not only did income levels during the 1990s tank, but spending also went backwards very quickly. That's in contrast to Russia, where spending levels remained fairly steady. Kazakhstan clearly accelerates on the back of rising oil prices in the naughties, growing much more rapidly than Turkey or Poland, but the surprise is Belarus which keeps pace with it and even grows faster in the latter part of the last decade.

This is interesting as what I suspect is happening here is that Kazakhstan is growing thanks to the oil effect, whereas the strength of the catch up effect in Belarus was equally powerful. I chaired the first ever Belarus International Investment conference in London in November 2008 and the deputy Prime Minister told me that they had only just used up all their Soviet era spare capacity and wanted foreign investment to continue the growth. The fact that Russia was subsidising their economy until 2008 in the form of cheap oil and gas prices also allowed the state to boost growth with massive spending. The combination of the end of the subsidises, lack of growth-producing spare capacity, and the international financial crisis have all combined to bring Belarus to its knees now.

And there is poor old Ukraine. Ukraine sells metal which, like Russia's energy, makes up about 60% of exports. And like oil, metal has seen prices surge over the last decade thanks to rising demand in China et al. However, this windfall doesn't seem to have much of an impact on the incomes and spending of the people. Indeed, according to this graph, Ukrainians suffered more than anyone else from the collapse of the Soviet Union, with both income and spending collapsing. Also they seem to have benefited the least in the following decade. In short we can say that the country has made some progress thanks to the "oil effect" but has seen little or no benefit from the catch up or reform effects.

Finally to Russia. Compare the trajectory of Russia and Kazakhstan and the oil effect is clear to see: both of them move at about the same pace after their economies take off in 2000. But Russia starts to streak away from Kazakhstan from about 2005 - the start of its boom years. One explanation is that oil drove growth between 2000 and 2005 but after that the other two forces came into play. As Poland also shows, if you can get two (or more) of these three factors to work together then you get a multiplier effect that allows your country to outperform all the others.

What of the catch up effect in Russia? I looked at the question of capacity utilisation in about 2005 in an article and found that most of the spare capacity had been used up by then so the catch up effect, in terms of empty factory seats, had been largely exhausted, while investment was taking over. However, there is still more catch up growth to be had as things that didn't exist in the Soviet-era, like supermarkets, are created.

But how does this compare to reform growth? That's hard to say. The conventional wisdom is there has been no reform in Russia, but this is clearly not true. In a note I wrote with Plamen Monovsky of Renaissance Asset Managers, we found that the earnings of the representative companies in each sector where the state had implemented reform massively outperformed the rest of the market. And this was true irrespective of what sector you looked at: banks, cars, retail, power and so on. However, the aggregate growth also shows that the reform effort has yet to have a universal beneficial impact on the economy as a whole, which is still growing in GDP terms by several percentage points below its potential.

What Russia's trajectory in this chart suggests is that from about 2006 onwards is that all three factors - oil, catch up and reform - had begun to work in concert (what proportion of each is still unclear) and at that point it was producing growth so exceptional that Russia was about to overtake even Poland, the star of Europe's transformation. Looking down the road post crisis then, it's becoming increasingly clear that Russia is at a crucial juncture. I have seen an increasing number of papers from the investment banks worrying about growth going forward, saying the state-led model the Kremlin favours is going to lead to stagnation.

Certainly the Kremlin is saying all the right things and clearly believes in the need for real reform - evidence: the privatisation programme and Russian president Dmitry Medvedev's anti-corruption drive - but the implementation is the key, as it always is in Russia. Still, what this chart suggests is that the reforms, incomplete and flawed as they are, are actually producing a beneficial effect; and coupled with the providential gifts of catch up and oil growth, Russia is in a strong position to continue to outperform.

Click here to see the new chart