02/19/2016 03:14 pm ET Updated Feb 19, 2017

World-Renowned Economist Sergei Guriev on the Russian Economy: Takeaways from his Speech at the Oxford Guild

On January 27, 2016, Sergei Guriev, a leading Russian economist and Professor of Economics at Sciences Po University in Paris, made a speech to the Oxford Guild entitled "Whither the Russian Economy." During his speech, Guriev shared his thoughts on Russia's economic growth prospects, the current economic crisis in Russia, and the linkage between economic conditions and the political situation under Putin. Below is a synopsis of Guriev's opinions on the state of the Russian economy, and what the future may hold for Putin's economic recovery efforts:

Guriev on Economic Growth in Russia Under Putin

Sergei Guriev argues that during Putin's first decade in power, economic growth was foundational for the social contract that upheld his regime's legitimacy. The consistency of 7-8% annual growth rates recorded in Russia during this period arguably surpassed the 1930s Stalinist economic boom in magnitude. The 2008 financial crisis came as a shock to many Russian policymakers who were largely unprepared for a scenario in which oil prices declined steeply and associated their popularity with maintaining income growth in their respective regions.

Russians did rely to some extent on consumer loans as real wage increases led to growth in car and house ownership, but the investment climate and corruption remained serious issues.

By 2012, the structural drivers of Russian economy growth had slowed considerably, and Putin at the state-level undertook many reform projects to reverse this trend. These included the Gref Program, Strategy 2020, Strategy 2035, and the 2012 Open Government Partnership. The drivers of the 2012-2013 financial crisis in Russia were structural and not cyclical; the origins are rooted in issues largely independent from the slowdown in Europe or the US. Russia's economy is not declining relative to its potential GDP but its potential GDP is actually declining.

The assumption that Russia's natural level of GDP growth is 4% has come under threat. Russian Prime Minister Dmitri Medvedev's 2013 statement that 4% is too low a threshold for Russia, which should be growing at a minimum of 5%, also is too optimistic given current conditions. Russia's recession does not fit the typical mold of economic decline as it has been characterized by inflation instead of deflation, low unemployment rates and large flows of consumer credit. Russia needs to have structural reforms to improve the investment climate, so spending more and more on stimulus could just create more inflation but not durable fast GDP growth.

Guriev on the Current Economic Recession in Russia

Guriev describes the 2014-15 economic crisis as a perfect storm where every wind was against Russia. Russia's economy began to decline steeply by the second half of 2014 as the combination of poorly-planned investments during the boom period and a unique confluence of low oil prices and sanctions relating to the annexation of Crimea plunged the economy into recession. Russia's reliance on oil revenues is not comparable to Saudi Arabia's for instance, as its share is only around 20% or 30% of GDP depending on the year you examine. Half the Russian budget comes from oil and gas taxes though, which creates a fiscal problem. The ruble has been devalued as the vast majority of Russia's exports are linked to oil prices.

Sanctions reinforced the decline in oil prices as they prevented Russia from borrowing its way out of the crisis to offset the oil price decline. 2015 witnessed a 4% fall in GDP and real incomes adjusted for inflation fell sharply. This is a big difference from 2009 where the GDP fell by even more but there was not a comparably large decrease in living standards. The bite from individual-level sanctions has been much more limited for the overall economy than from the sanctions that restrict borrowing.

The Russian government has allowed inflation to continue, making it unlikely that inflation in Russia will drop to its target of 6% in the short-term. The target of 6% has been consistently announced year-on-year, but Putin's tenure has been characterized by double-digit inflation even during more prosperous periods. High inflation could damage the investment climate further, but it is necessary for keeping a balanced budget.

Capital flight from Russia averaged 3-4% of GDP prior to the current crisis, but the problem ballooned markedly to 12% of GDP in 2014, leaving the Russian people and investors in a panic heading into 2015. The Russian government's approach to tackling this issue has stabilized capital flight, though the problem still remains large. Capital outflows are a product of sanctions, and Western investors remain cynical towards Russia even though the ease of doing business ratings for Russia improved substantially under Putin. Putin raised the ease of doing business rating from 120th to 51st in four years with a long-term target of reaching the top 20 in the world. Much of the growth is attributable to changing measurement methodology, however, making a top 20 result unlikely.

Guriev on Putin's Response to the 2014-2015 Recession

Guriev argues that the Russian government learnt many lessons from the 2008-2009 financial crisis in its handling of the current recession. The ruble was allowed to float unlike in 2008, on the assumption that Russia will receive more rubles for its exports than before, which translates into more money. The flexible exchange rate also helps buffer the shock resulting from oil price declines. Exchange rate flexibility is useful as Russia has more leverage than struggling EU countries like Greece, which are bound to the euro. Despite the volatility, floating the ruble was an effective policy.

The fiscal shock from the 2014 crisis was more problematic. Putin decided to cut expenditures right away even before the reserve funds were used up. The budget developed in summer 2014, which began to be drafted in February 2014, was based on $100 a barrel oil originally but was signed into law when oil prices were at $45 a barrel. Spending was cut by 8% relative to the original plan, keeping the deficit in check for 2015. Putin cut the budget by a further 8% in real terms for 2016, with pensions being indexed at just 4% with inflation at 15%. Military spending also decreased in 2016, with nominal declines in health and education spending. Military spending in Russia is approximately 4% of GDP, and since Kudrin's dismissal, Russia has found it hard to afford escalated military activities.

Guriev on Russia's External Debt Problem

Russia has made considerable progress on the issue of external debt, despite an oft-quoted statistic of $700 billion in external debt in early 2014 being used by policymakers as proof of Russia's uncompetitive position in the world economy. About 25% of the debt was denominated in rubles and some was held by Russian businesspeople (effectively intra-company debt). Sovereign debt is 13% of GDP; debt levels are around $520 billion as a lot was paid off in 2014-2015 and one-third of this debt was held by Russian businesses. Russia currently possesses $370 billion in reserves, which has made the problem less serious. Monitoring external debt is very important for the Russian economy, as Eurozone banks holding the debt fear a depreciation of assets that could lead to a financial panic.

Guriev on Corruption in Russia under Putin

Corruption in Russia is often underemphasized in plans to tackle the country's economic challenges due to prevailing tropes that other countries are corrupt or that Russia has made a great deal of progress and has been marred by endemic corruption for centuries. There are countries like Turkmenistan, Azerbaijan or Lebanon with similar levels of development to Russia that are more corrupt than Russia as of 2014, and Russia is approximately on par with Kazakhstan.

But overall, Russia is one standard deviation away from the norm for countries of its development level, which suggests that it is unusually corrupt. Efforts to improve Russia's investment climate prior to the 2012-2013 crisis also fell short.

Guriev on Russia's Economic Growth Prospects

The initial consensus amongst Russian policymakers was that the Russian economy would grow from 2016-2017, but that is now correctly regarded as unrealistic. International organizations predict a 1% decline in growth, but that assumption is based on higher oil prices. If oil prices remain at $30 a barrel, Russia could face a 3% growth decline.

While stability and the assumption that one will be paid on schedule is important for economic success, Russia has shifted away from 3 year planning towards 1 year planning, as conditions are unpredictable. The deficit will be covered in 2016 but not by 2017, as the reserve fund will likely be gone by the end of 2017 if current trends persist. If oil prices stay at $30 a barrel, the reserve fund will likely disappear before the end of 2016 as the projected 6-7% of GDP budget deficit will surpass the 4.6% of GDP held by the reserve fund. Sanctions prevent borrowing, so Russia will have to cut pensions again in order to pay its obligations. Russia can theoretically borrow from China, but Chinese credit is insufficient to cover the gap.

Official forecasters have been more optimistic predicting 2% GDP growth once the recession is over. As late as 2013, the Finance Ministry regarded 2% growth as a worst-case scenario; now it is an optimistic target. The recognition that steady state growth in Russia has declined has seeped even into the official discourse.

Guriev on Structural Factors Impacting Russia's Economic Growth

It is often hard to diagnose the structural problems afflicting Russia, as some structural characteristics that have historically been labeled as problems have actually been enablers of growth in the past. Russia has a lot of physical and human capital. Many analysts see agriculture in Russia as a weak point, but Putin has pushed for land reforms and grain exports to revitalize this sector. The quality of human capital is not high, but even the highest skilled Russians are leaving Russia. The brain drain problem proves that Russia does not inherently lack human capital but needs to be more effective in harnessing and using the human capital that it possesses.

Demographics are poor in Russia but are not as bad as previously feared. The official forecast for 2013 was that Russia would lose 4 million people due to natural decline but gain 5 million people through immigration, which is a completely plausible statistic, notwithstanding the social tensions that result from immigration. Migration could be reduced if Central Asian countries become more prosperous compared to Russia. Kazakhstan's GDP per capita is now higher than Russia's for the first time, which could lead to a shift in Kazakh migration patterns.

Labor productivity remains a problem, despite the success of Yandex (the Russian Internet company which displaced Google) and other companies. The idea that Russia is unsuited for capitalism is unsubstantiated. The experience of East Germany demonstrates that an adjustment period is necessary and that Russia could eventually succeed with Western managerial techniques and modern equipment. The best firms in Russia like Gazprom can compete with the best in China or the West, but lower-tier firms drive down productivity.