Ben Aris in Moscow -

This is a bean counter crisis in Russia. There have been no significant bankruptcies, no bank runs, no defaults, debt remains low and the budget is still in the black. The main victims so far have been tourist agencies as Russians en masse cancel their now increasingly expensive foreign trips. Rather than dealing with a firestorm, the challenge the Russian government faces is what to spend its (albeit smaller) surplus on to help drag the economy out of recession this year and maybe next. Infrastructure! ratings agency Standard & Poor's answered in a report released on January 13.

One of the quirks of the Russian budget is that because the government prices spending in rubles but earns about half a trillion dollars a year in dollars from oil taxes, the state is one of the biggest beneficiaries of devaluation. And there is no better place to spend that money than on roads, railways and airports to lift a spluttering economy, according to John Maynard Keynes in his now legendary book, “The General Theory of Employment, Interest and Money”, published in 1936 during the Great Depression. “Thus public works even of doubtful utility may pay for themselves over and over again at a time of severe unemployment, if only from the diminished cost of relief expenditure,” Keynes wrote.

The US might have had its economic forecast upgraded by the World Bank on the same day as the S&P report came out to 3.2% from 3.0%, but global growth is now predicted to expand by just 3% this year and 3.3% in 2016, after predicting in June growth of 3.4% and 3.5%, respectively.  

"With global infrastructure investment needs now in the tens of trillions of dollars – figures that are essentially incomprehensible to most of us – it's easy to see the problem as insurmountable. The result is that too often, we forget that even a relatively small increase in spending on infrastructure can yield outsized returns – especially if investments are executed in a wise, targeted way," S&P said in the introduction to its report, “Global Infrastructure Investment: Timing Is Everything (And Now Is The Time)”.

Panama effect

The reasons infrastructure spending helps are two-fold. First is the relief it brings in the short run by boosting aggregate demand (economic output), putting pay in pockets and chickens in pots. Second, in the longer run infrastructure is an economic multiplier: S&P estimated that each dollar spent on infrastructure in the Eurozone will produce $1.4 worth of economic growth in the following three years. A study by International Monetary Fund economists last year came to a similar conclusion: a one percentage point increase in infrastructure spending leads to a 0.4% boost to output in the first year and a 1.5% increase four years out.

For a country like Russia that is facing a deep recession – estimates vary from Fitch Ratings's forecast of 2.9% to senior fellow at the Peterson Institute for International Economics Anders Aslund's estimate of an 8-10% contraction – the effect of infrastructure spending would be even more dramatic. Following several generations of underinvestment in infrastructure, simply improving transport could produce the kind of effect that the Panama Canal had on international shipping when it opened.

And as luck would have it Russia plans to massively increase infrastructure spending; prior to the 2008 crisis, the Kremlin rolled out a $1 trillion infrastructure investment programme. Since the 2008 crisis, this number has been greatly reduced; on January 15 the Kremlin said it would cut all spending, except defence, by 10%. But the government continues to talk about pumping hundreds of billions of dollars into infrastructure and is working on issuing infrastructure bonds to finance it.

Low multiplier

A glaring omission from the S&P report is any mention of what happens if Russia spends on infrastructure. Despite discussing Russia's BRIC peers, S&P gives no estimate for Russia's multiplier effect. Given S&P estimated the multiplier for the other members of the BRIC quartet at between 2.0 and 2.5 times, Russia presumably has a similar number.

But omitting estimates of Russia's multiplier perhaps has something to do with the size of it being a contentious subject. In their book, “Russia After The Global Economic Crisis”, Aslund, self-exiled top Russian economist Sergei Guriev and fellow of the Centre for Strategic and International Studies Andrew Kuchins wrote: "Most recent detailed studies put the size of the multiplier at 1, ie. GDP increases only by a dollar in response to a dollar increase in government expenditures." The problem is that all the benefit is eaten up by corruption and accrues to the oligarch lucky enough to win the contract, rather than to the economy as a whole.

Russia is not alone in this problem; consultants McKinsey & Co. estimated in 2013 that even in the developed world infrastructure projects could generally be completed at two-thirds of current costs if they are evaluated, planned and executed more carefully.

However, in a worrying sign that nothing has changed in Russia, on January 14 the Kremlin announced that the winner of a tender worth billions of dollars to build the Kerch bridge to link mainland Russia with the newly annexed Crimea peninsula was Russian President Vladimir Putin's former judo partner and the billionaire Kremlin insider Arkady Rotenberg.

Examples of demonstrably expensive infrastructure investments in Russia abound. "As we argued earlier, it is better to withdraw subsidies from inefficient enterprises and spend these funds for direct support of Russians suffering from the crisis," the academics argue in their book.

Will Russia's infrastructure spending make a positive difference? Now we will find out. The Kremlin has no choice but to make reforms and reduce corruption if it is to avoid a Latin American-style decade of stagnation. Long-term Russia watchers are hoping that Putin will replace Russian Prime Minister Dmitry Medvedev with the well-respected former finance minister Alexei Kudrin to oversee the process. But more likely Putin will simply hunker down and spin out Russia's cash reserves for as long as he can. Keynes himself foresaw the essence of this problem: “The difficulty lies, not in the new ideas, but in escaping from the old ones, which ramify, for those brought up as most of us have been, into every corner of our minds.”

The future is probably not as bleak as Russia hawks like Aslund make out, as the Kremlin has already taken its first faltering steps towards cracking down on corruption and begun the process of making structural reforms. Medvedev, speaking at the Gaidar forum on January 15, stated: "Russia needs to completely transform its economic model."

Keynes argued that ultimately it is hard to get the infrastructure spending completely wrong because ordinary people aspire to a better life and will find a way to cope, even if it takes time. "This [Great Depression] is a nightmare, which will pass away with the morning. For the resources of nature and men's devices are just as fertile and productive as they were. The rate of our progress towards solving the material problems of life is not less rapid. We are as capable as before of affording for everyone a high standard of life… and will soon learn to afford a standard higher still. We were not previously deceived. But today we have involved ourselves in a colossal muddle, having blundered in the control of a delicate machine, the working of which we do not understand. The result is that our possibilities of wealth may run to waste for a time — perhaps for a long time," Keynes wrote in the “Nation and Athenaeum” published in 1930.