Human Decapitalization.
The Unsolvable Problems of the Russian Labor Market
June 27, 2023
  • Vladimir Gimpelson

    Professor of Practice in Russian Studies in the Department Agricultural and Applied Economics at the University of Wisconsin-Madison
  • Maxim Blant
    Economic commentator, Radio Free Europe/Radio Liberty

Vladimir Gimpelson, Professor of Practice in Russian Studies in the Department Agricultural and Applied Economics at the University of Wisconsin-Madison, discusses the state and prospects of the Russian labor market. From the second half of 2022 onward, the “demographic hole” has been overlaid by war losses, emigration, and structural changes directly related to the war.

One of the main topics in Russia in recent months has been an acute shortage of personnel. At the same time, observers talk about the “fantastic” adaptation of the Russian economy to sanctions and military challenges. How do these two theses fit together, and how acute can the situation in the Russian labor market be called?

Let me start from afar. For 30 years, officials and politicians in Russia have viewed unemployment as one of the key problems and have struggled with it. At the same time, the crises experienced by the country did not, as a rule, lead to a serious reduction in employment. Unemployment was growing, but not by much, which surprised everyone. And so it went from crisis to crisis. Each time, negative expectations were higher than reality. This is explained by the fact that in Russia, due to a number of circumstances (and they were formed in the late Gorbachev years), a market model, which dampens high unemployment, has developed. This is due to the fact that it is quite easy to lower wages, which makes it possible to adapt to increased costs. But the costs of layoffs, the costs associated with the optimization of the number of employees, are high. This is enshrined in the Labor Code, which provides for high severance payments. And officials interfere when they see the risk of layoffs. That is why companies, if they can reduce their number of employees, do not reduce it quickly, but gradually squeeze people out one by one.

Mass layoffs, which are characteristic of, say, the American economy, are virtually impossible in Russia. This is compensated for by a very low minimum wage and, accordingly, tiny unemployment benefits. In addition, there was a huge segment of semi-formal employment, which like a sponge absorbed those who lost their jobs in the corporate sector. It was impossible to get by on welfare — you had to go into that sector.

This model turned out to be quite effective. This is not to say that it is unique to Russia. This model is typical of a number of Latin American countries. And the point is that if you have weak unemployment benefits and social protection, there can be no high unemployment, but the gray sector can be a source of income.

Now things have started to change, and the reason is the demographic situation. The total number of employees in the labor force has not fallen much so far, but their age composition is changing. There are fewer and fewer young people — and they are the most productive. Productivity goes up until the age of 40 to 45, after which it hardly grows at all. According to our projections that we made before the war, the number of employed people between the ages of 20 and 40 should be down by about a quarter by 2030 compared to 2020. That in itself is a huge shock. And then, in addition to demographics, there is emigration, mobilization, and the need to increase employment in industries that are engaged in import substitution or work in the military-industrial sector. It turns out that, on the one hand, the supply of the most productive segment in the labor market is falling, and on the other hand, it is necessary to provide a reallocation maneuver.

This model, which has been extremely effective for fighting unemployment, is proving to be a big brake on quick maneuvering. And this problem is very difficult to solve. In order to solve the problem of the labor shortfall in the relevant militarily-relevant industries under the current demographic and other circumstances, we need to free up this workforce somewhere else. And this is not easy, because the very institutions that help to reduce unemployment do not allow this to happen.

The problem is also that it is not enough just to free up workers. People need to be supported for as long as they are unemployed. That is, we need benefits and a system of social protection, which in fact does not exist. We need an effective system of retraining, which is also virtually nonexistent. And often those [who need to be attracted to the military-industrial sector, etc.] need to be paid higher wages than they were getting — otherwise they will resist. And that’s not so easy either.

The industries that need labor are often tied to government contracts. This also implies fixed prices and, consequently, limits on wage increases. The marginal cost of hiring new workers at higher wages is much higher than just the cost of hiring an additional worker. When we deal with mass professions, hiring someone with a higher wage means everyone else has to raise it as well: it is very difficult to pay for the same thing differently within the same organization. Everything instantly becomes known and leads to unnecessary conflicts. So even if it is possible to pay a new employee a little more in theory, the company cannot actually do it in practice.

All of this suggests that
“We are not dealing with scarcity as some absolute phenomenon, but with the inefficient use of existing labor resources.
Uralvagonzavod, the world's largest main battle tank manufacturer, is located in Nizhny Tagil (Sverdlovsk Region). Tank factories, as well as other military industrial plants currently experience a shortage of work force. Source: Wiki Commons
A number of sectors — we see this in the data — are shrinking. There’s a surplus of labor that could be used, but in the current model it’s almost impossible. And frankly, I don’t see a way to solve this problem. Because every element of the release-support-retrain-hire chain is very complicated. It is technologically, politically, institutionally, and financially complicated. When everything has to be done simultaneously, the complexity grows manifold, and the demographic situation, meanwhile, continues to deteriorate.

Nevertheless, I do not like the term “labor shortage.” Those who grew up in the Soviet economy understand that shortages (unless we are talking about something physically extremely rare) are a reflection of price rigidity. If prices are flexible, supply and demand always find an equilibrium point.

If we look at the problems of today in a regional perspective, the shut down auto companies and the military industrial plants, for instance, tank factories which experience a shortage of work force, are located in different places. In order to ensure the flow of workers, it is also necessary to create conditions for horizontal migration. People must be helped to move, provided with housing in a new place, and social infrastructure must be prepared for this. How solvable is this task?

It is unsolvable. This is in addition to the four problems I listed: release, support, retrain, hire. They are incredibly complex, even if everything is happening in one locality. If we get another fifth component — moving and resettling — then the complexities multiply by an order of magnitude. Somewhere, someone can probably do something, but as a working system, it’s impossible to imagine it. In addition to the extreme complexity, it is also incredibly expensive. So if you look at the Rosstat data, you can see that in the growing sectors that we are talking about, the number of hours per employee is growing, but the average headcount, if it is growing, is doing so much more slowly.

If there is a shortage of engineers, the number of engineers will not increase instantly, no matter how much you raise salaries. You can lure someone from a neighboring company or from another industry, but it won’t change the whole economy — there will still be a shortage. There will be an overflow, but it will take years. And this is true for any market. It takes time to train qualified personnel, but so far the situation is developing in the opposite direction. There are now quite a few alarming estimates about the loss of human capital — because of demography, because of emigration, because of mobilization and war dead. Is this loss recoverable?

There are two questions here. The first is about the elasticity of the supply of notional engineering labor. Of course, it is not very elastic. But we have to keep in mind that even today the Russian economy receives a huge number of engineers from the higher education system, while the number of engineering jobs is relatively small. The output of engineering personnel seriously exceeds the actual demand. It is just that a significant number of people who get an engineering education do not go to work as engineers. This is also because the salaries there are relatively low. I’ll abstract from the quality issue for now. This is a separate story in its own right.

But again, we can talk about the fact that a huge number of engineers by education — and often not only by education — are being inefficiently used. Create better conditions for them, and some would return to their profession or not try to leave it.

The second issue is the loss of human capital. And it’s not just engineers or anyone else who has left. The entire system of higher education is collapsing. And it’s not just because someone has left, either. The formula for the ongoing “sovereignization” of education is as follows: the main thing is to teach patriotism, which comes down to outright anti-Westernism. Everything else is irrelevant. A process is taking place within this system, where the best are leaving and the worst are taking their place. This process is happening fast and on a mass scale right now.
The worst fill the places of those who have either left Russia entirely or who have simply decided to leave the market, have lost the ability to continue their work, and so on. And the same process will determine the quality of education for years to come.”
The problem is also that the restructuring of the economy as it is happening now is a throwback. Well-known economist Branco Milanovic mentioned in March last year that we are witnessing an interesting experiment: Russia will try to carry out technologically-regressive import substitution. In practice, this means that a return to yesterday’s technology will also revalue human capital on the downside. If more-qualified people do less-qualified labor, this is also a blow to human capital.

Recently there has been an exaggerated focus on IT specialists, but when it comes to technological regression, we need completely different people. To what extent are the government’s actions in this sense adequate to the real situation? After all, the structural adjustment that has been talked about so much since the war began has so far resulted in a hypertrophied growth of the military sector.

If we look at those who are called “IT people,” we see that this is a relatively small group. It’s about 1.5% of the workforce. Everyone is obsessed with “digitalization,” so this group gets special attention, perhaps undeservedly. I don’t think doctors, for example, deserve any less attention. But there is already talk that the future of people in IT professions may not be so bright. As for the restructuring of the economy, which is shifting in favor of the military-industrial complex, it certainly causes its disproportions in the labor market. And sooner or later the time will come when we will have to decide what to do with all these people, how to return them to the civilian economy and what to do with their skills.

And how will it be possible to bring them back? In the late 1980s and early 1990s, we had already been down this road and pinned a lot of hopes on “conversion.” We thought that military enterprises would start producing miracle irons, etc., and then life would get better. It did not work out so well. What will Russia’s post-war economy encounter?

That time has yet to come. It is possible that the next generation of experts will have to answer these questions. But right now, with a “shortage” of labor (again, I don’t like this term, so let’s put it in quotes), we are pushing more and more of the labor supply into sectors that will have to shrink at some point. Then the inefficient distribution of labor will reach a climax. With even worse demographics, we will have to squeeze this segment, and this is only possible by bankrupting businesses and laying off workers en masse, which is always extremely difficult. At the same time, the total number of employees will continue to shrink. And we understand that there can be no economic growth if labor is reduced as a production factor — unless this process should be more than compensated for by technical progress. But there can be no technical progress under these conditions.

What do we get in the foreseeable future?

We already have an inefficient distribution of labor. Going forward, this inefficiency will increase.
We will be losing human capital altogether. We are laying the groundwork for worse human capital reproduction in the future.
And it’s not just education, but also the healthcare system, which is underfunded and losing numbers. People’s health is deteriorating in the crisis. And in addition, the overall demography leads to a contraction of the workforce.

What model should we be waiting for? The late ’80s and early ’90s? North Korea? What fork sin the road do you foresee?

You don’t have to compare it with what you had. It is quite possible that there will be something that hasn’t happened yet. So I wouldn’t get attached to the examples that easily come to mind. You have to keep in mind that the models of stagnation, the ’90s, and North Korea all took shape under conditions of at least some sort of growing population. Now we are dealing with a shrinking and aging population. Over the next 10 years, we will continue to lose the most productive category of people in their 20s and 40s. That’s not going to change.
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