‘No One Could Have Predicted The Scale Of The Restructuring’
October 25, 2023
  • Natalia Zubarevich
    Professor of the Department of Economic And Social Geography of Russia of the Moscow State University
  • Maria Bozhovich
Regional economist Natalia Zubarevich talks about where the Kremlin is getting the extra financial resources it needs, how the automotive industry is slowly transitioning to Chinese brands, how the balance between center and periphery is changing and why Russians’ enormous capacity to adapt has surprised her.
The original interview in Russian was published in Pravmir. A slightly shortened English version is republished here with their permission.

Did the special military operation do anything positive for the economy?

Sure, the salaries of everyone involved in the military-industrial complex have gone up – I think they are happy about that. More than 600,000 mobilized and contract soldiers started to receive completely different wages. I do not know how happy they are about that, but their families are definitely happy.

If we ignore the humanistic component and take the economy as an increase in prosperity and industrial consumption, then those regions that are home to defense enterprises and seeing a trickle-down of money from the budget are benefiting?

It is trickling down to many regions. Benefits for low-income families with children have increased sharply. In 2023, they amounted to about RUB 1.5 trillion, which is a lot. In addition, mobilized soldiers, and contract ones too, are mostly people from poorer places, which will also see an inflow of money. Still, I cannot bring myself to say, “Buryatia has benefitted the most [from the war].”

It is all quite spread out across the country.
In the first half of the year, almost across the whole country we saw a recovery in income growth that covered the decline of 2022.
The automotive plant Moskvich (formerly Renault Russia). In July 2022, after Renault announced it was leaving Russia, the KAMAZ and the Moscow city government agreed on an even split in the capital of the Moskvich plant. Source: Wiki Commons
I cannot single out particularly “preferential” regions, especially because of the problems with the quality of household income statistics. For example, growth is not visible in some Far East regions, though it is probably because of statistical errors.

Social payments are rising, more money is going into manufacturing – at whose expense?

There are several new cash flows. The first is additional taxes on big businesses. More and more are being invented: a tax for exchange rate changes (if you are an exporter and the ruble is cheap, then c’mon, pay up), then the so-called windfall tax (on an unexpected increase in prices for exports). Now export duties are also being increased.

The second cash flow is local bonds. While the Central Bank had a low key rate, it (government bond issuance) was advantageous for the federal budget. But now, when the Central Bank has been forced to hike rates, bonds are unlikely to be issued as actively, as it will be expensive for the state to service them. After all, bondholders need to be paid something, they must get a return.

The third source is the National Wealth Fund. It is held in FX and gold, while the ruble has weakened. In 2023, RUB 1.5 trillion has been taken out of the fund, but the amount of yuan and gold has actually remained the same.

From the second half of 2023, oil and gas earnings began to rise. The same thing happened in the first half of 2022, when there were crazy prices for our export products, primarily oil and gas. Then they fell, and in the autumn of 2023 they went up again. Even if they do not reach 2022 levels, there will no longer be such a hole in the budget due to weak oil and gas earnings. By the way, what is happening now in the Middle East will also affect prices, as there are fears that Iran will enter into the conflict and additional sanctions will be imposed on the country. Then there will be even less oil in the world market, and it will be more expensive.

Meanwhile, other revenues are not going anywhere. Prices are rising, and alongside them VAT [receipts] rose 26% in January-August. The ruble is getting cheaper – the external VAT on what we import is rising, because the tax is calculated in rubles, and there are a lot more of them.

Starting this year, people have started to pay tax on deposits of more than RUB 1.3 million, and it is transferred entirely to the federal budget; the region no longer receives anything. There is also an additional tax – if your salary is more than RUB 1.2 million, then not 13%, but 15% is deducted from the amount above that level. And this money also goes to the federal budget.

There is no need to impose additional taxes on small businesses. Taxes are not being raised for the population either.

But all this does nothing for the development of the economy?

Such decisions are made without the economy in mind. You may say there are “ineffective expenditures due to non-economic factors.” It is very profitable for certain groups of businesses and certain groups of workers. Workers at military-industrial complex enterprises have a draft exemption plus double wages.
Indeed, their well-being has improved significantly.

In addition, technically this means an increase in gross domestic product. It is difficult to isolate the contribution of this particular part of the economy, but we all understand perfectly well that it is adding percentage points to growth.

There is another phenomenon that officials like to hold up: low unemployment.

Several key factors came together here. The main one is demography. The generation of 23–25-year-olds is entering the labor market, and it is approximately 30% smaller than that of people aged 35 years. This is a consequence of previous wars, which is still noticeable, and the collapse of the birth rate in the 1990s and early 2000s. A large generation will gradually leave the labor market, which is now delayed because the retirement age was raised, so all this is not so noticeable for now. But over time, our workforce will steadily decline.

Add in 300,000 mobilized men, add in more than 300,000 contract soldiers – there is another 600,000 taken out of the economy.

It is harder with those who left the country, as we do not know the number, although estimates of 500,000-700,000 seem plausible. But some have returned, and the majority of those who left continue to work for Russian firms remotely. So, they are not off the payrolls.

Is it true that because people are now getting more money but working worse, productivity is falling?

Productivity is indeed falling, Rosstat reports. Production volumes are rising significantly slower than wage growth. In January-July, nominal wages increased 13% (this is at firms, excluding self-employed individuals).
“People are being recruited for specialist jobs that urgently need to be filled, but this can only be done by increasing wages.”
You drive around Moscow and see an unprecedented number of new cars with unusual names. Dealerships that used to sell European and Japanese models are changing their signs.

Since the summer, we have seen a major pickup in car loans. People waited for a long time, but now they are mentally ready to switch to Chinese cars.

I asked my students: “do you understand that your first car will be Chinese?” Yes, they understand. Between a Chinese-made car and the LADA Granta the choice is obvious. I also asked: “will you quickly switch over to Chinese computers?” They said no – spare parts are relatively inexpensive, parallel imports are well established and you can keep your old computer in working order for a long time.
Chinese Chery car on a Moscow street. Source: VK
Can automotive regions, such as Kaluga and Kaliningrad, switch to assembling Chinese cars?

Where Renaults were previously assembled in Moscow, assembly of the Moskvich 6 has already been announced, which is indistinguishable, down to millimeters, from a Chinese model. Kaliningrad and Yelabuga will also switch to Chinese assembly – the lines are being reconfigured. This is not a quick process, and it requires investment.

But if in good years you had produced 200,000 cars, will you reach the same level with Chinese assembly? Nobody knows, but, in my view, it will not reach the scale that Volkswagen, Renault, Toyota and the Korean companies had. Also, no one knows whether the Chinese will agree to supply components for assembly, or whether it is more profitable for them to just sell finished products.

Overall, the automotive industry is still in a severe depression.

How does this affect people’s lives? Have they been let go?

They were not let go until August 22. At first, they were paid full salaries, then they were moved to part-time and accordingly received part-time salaries.

But it is clear to me that, for example, there will be no big problems in Kaluga, [since] there are defense enterprises there that need labor. In Kaliningrad the situation is tougher – apart from the Yantar Shipyard, there are no large industrial enterprises there.

Still, given the labor shortage, the employment problem will solve itself, even if some people will have to be retrained.

A blue-collar worker who knows how to work with his hands will definitely be in demand, so the shutdown of automotive plants did not have a big impact on unemployment even in 2022, and even more so now.

When we talk about the depression in automotive regions, we mean a decline in industrial production without clear signs of an increase in unemployment.

When the ruble collapsed, a meme appeared: “it’s great – there’s only one dollar, but a hundred rubles.” If commodity prices correlate with the ruble exchange rate, then why is it falling?

Because now the ruble exchange rate is linked to the balance of exports and imports. We buy for FX and sell for rubles, rupees, yuan. At one time, Russia insisted on this, because otherwise payments passing through banks could be seized. But straight payment in rubles, yuan and rupees is safe. In addition, this makes it possible to offset imports. You bring petroleum products somewhere, and you get equipment or something else from there. With China, we have almost equal exports and imports, and there was even a period when exports from Russia to China exceeded imports due to a jump in oil and gas prices.

The point is:
FX is now in short supply. This is the main factor in the ruble’s depreciation.
Yantar Shipyard, Kaliningrad. Source: Wiki Commons
The high price of oil has a downside: all of it is exported, which has created a fuel shortage. Does the state have to pay more for companies to leave oil in the country?

If we take oil and petroleum products together, then about 40% is exported. Of these diesel fuel is the most exported, with half of what is produced in Russia being exported. Export volumes began to decline only in 2023. This was somehow coordinated with Saudi Arabia, and oil began to rise in price.

Now, regarding the recent diesel and gasoline crisis: from 2019, the government introduced a “reverse damper” regime, where oil refineries were paid extra to keep their production in the domestic market. This damper rose year after year, and by 2022 it significantly exceeded RUB 2 trillion. Back in the spring there was talk that it would be halved, but the actual decision was made in September. Meanwhile, world prices had already begun to rise starting in the summer, [meaning] exports became extremely attractive. It has become much less profitable to sell in the domestic market.

Now, it has been decided that exports will only go through two product pipelines, without intermediaries, while half of production should be left in the domestic market. This will partially stabilize the situation; moreover, a pipeline is not hard to control.
But this is not the main thing.

What is the main thing?

Now, [prices] have skyrocketed for diesel, and there is no fuel for a harvester. Next month, something else will go off – for example, medications for diabetics will disappear.

Now, it is prohibited to sell grain in the global markets below the price recommended by the Ministry of Agriculture of $270 per ton. But the world grain market has gone down, and France, Bulgaria, Romania are offering grain at lower prices. Our traders are losing tender after tender; the granaries are overstocked.

You want our grain producers to earn more? Great. But the only result will be an oversupplied domestic market and falling domestic grain prices. Agricultural producers will have less money to purchase agricultural equipment, fertilizers, and the list goes on.
Or they said that now at least half of what you sow should be domestic seed. The only problem is that it is worse and there is not enough.
Until now, the growth in Russian crop yields – of sugar beets, corn, potatoes and, to a lesser extent, grain – has been driven by imported high-yield seeds. World agricultural genetics is better, what can you do? Foreign seeds, combined with fertile Russian soil, have delivered excellent results in the agricultural sector. Let’s see what happens to yields next year.

And I can give you dozens of examples of such “manual steering.” It leads to imbalances, to some deterioration, but someone always comes out on top. Now, big businesses are starting to buy seed farms. And the loser will be the farmer, who will suffer in terms of productivity, though no one will notice. We already fully provide for our needs in sugar beets, corn, potatoes, while in terms of grain, Russia is the second biggest exporter in the world.

How does a free market mix with a command economy, with such “manual steering?” What could this lead to?

Recommended export prices are not yet planned, fortunately. But there is a plan for the military-industrial complex.

A decision on it was made in 2012, and by 2019 it had been generally implemented. Back then, spending on defense, where the main thing was state defense orders, reached approximately RUB 3.5 trillion. Last year, it was already close to RUB 5.0 trillion. In 2023, as is penciled in to the budget, it will be more than RUB 6.0 trillion, and next year RUB 10.8 trillion is planned, or 29% of all federal budget expenditures.

And we started at less than 20%.

Every third ruble goes to defense and national security – in total it is more than 35% of expenditures.

Are social payments taken into account in the budget?

You bet! Another seven-odd trillion rubles goes to social policy. More than half of that is transfers to the pension fund, since insurance payments collected from employers and from our salaries do not cover all the pensions that need paid.

Less than half goes to support so-called federal beneficiaries – disabled people, Chernobyl liquidators, Soviet-Afghan War veterans and many more.

Plus “maternity capital.” Next year, excluding maternity capital more than RUB 1.3 trillion will be paid out to families with children, while about another RUB 500 billion will be maternity capital.

Do you think this expected spending will be fulfilled?

The penciled in budget revenues for 2024 are very optimistic, so we will see. I do not make any guesses at all, because the situation changes every six months, or even faster.

Remember how at the beginning it seemed to us that everything would be very quick and very painful? This turned out not to be the case.

The economy proved itself robust enough, business was fast enough to reorient itself. No one could have predicted the scale of the restructuring.

Is there anything else that you see currently that you did not expect whatsoever?

I understood that society was absolutely conformist, though I still did not expect that incredible measure of psychological adaptation. People have isolated themselves and are trying to live their normal, old lives. They take everything that is happening for granted: I cannot change anything, so I will live in the given circumstances.

I do not judge anyone, and I do not make moral judgements. People are looking for a method of adaptation that is within their power. But this is very dangerous for the future.
It will be very hard to bring the country back even to the level of humanization that had emerged in recent years, to the level of benevolence that we had seen just recently.
In the understanding that we need to help others we have slid so far that we will have to claw our way back for a long time to come.

Your students, young people, may witness some changes that we will not...

We will witness something. Just today at a lecture I showed which groups of the population are receiving flows of additional income. It will be interesting to see how the regions and the country change structurally by the end of 2023, and maybe 2024. Up until now, we observed a great divergence between the biggest cities and the “periphery” and “near-periphery,” which has gone on for almost 30 years. Everything connected with living, making money and education was concentrated in the biggest cities. The country became polarized. But now we will see an evening-out in incomes, as the periphery has become the main destination for additional benefits and wage increases.

That sounds good, actually.

If it was only that low-income families would receive additional money, I would be all for it. But we understand that this is not the only thing that is happening...

The young, educated, well-earning population left the biggest cities, spreading out across the world.

And still, nothing will change in terms of modernization and education – they will remain [centered] in the big cities.

State defense orders do not warm my soul. But I cannot throw a stone at the workers of these enterprises. Their salaries were raised, for many this was simply salvation. Do you know how many IT workers in Bashkortostan and Sverdlovsk Region quit their jobs with good salaries and went to the public sector as soon as it was announced that employees of defense enterprises would receive draft exemptions? This is how labor is finding its way to the defense industry.

Is it already clear what will happen next?

No, it’s not. I understand that the current situation may stay frozen, and I may not live to see it change. But I do not have a feeling that what’s happening is predetermined. I have lived a long time, and in my life I have seen a lot of zigzags, leaps, somersaults by this state. When you have a lot of life experience, it is better to rely on it and move away from categorical judgements and always cultivate both irony and self-irony.
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