ECONOMY
‘The Main Parameter Is How Much People Are Willing To Tolerate A Declining Standard Of Living’
November 27, 2024
-
Konstantin Sonin
Economist, Professor at the University of Chicago Harris School of Public Policy -
Tatiana Rybakova
Journalist and writer
In an interview with Republic, economist Konstantin Sonin explains what a recent report on the Russian economy – which argues that “Putinomics” can both keep the war going and ensure economic growth – gets wrong.
The original interview was published in Republic. We are republishing here a slightly shortened version with their permission.
In your view, to what extent do the findings of the recent report by Sergei Aleksashenko, Vladislav Inozemtsev and Dmitri Nekrasov (“Dictator’s reliable rear: Russian economy at the time of war”; see Inozemtsev on it in Russia.Post here) correspond to reality? Is “Putinomics” really so successful and robust?
It seems to me, as it does to my colleagues, that the Russian economy has become more military-oriented. In the sense that money has been taken away from education, health care, investments in infrastructure and consumption and transferred to military production. At the same time, there are a number of artificial statistical effects that create the impression that the economy as a whole is growing.
The fact is that it is not growing. In fact, two processes are taking place in the economy: a decline in people’s standard of living and a decline in consumption – in both the quantity of goods consumed and the quality of goods consumed. This is how the war is being financed.
In your view, to what extent do the findings of the recent report by Sergei Aleksashenko, Vladislav Inozemtsev and Dmitri Nekrasov (“Dictator’s reliable rear: Russian economy at the time of war”; see Inozemtsev on it in Russia.Post here) correspond to reality? Is “Putinomics” really so successful and robust?
It seems to me, as it does to my colleagues, that the Russian economy has become more military-oriented. In the sense that money has been taken away from education, health care, investments in infrastructure and consumption and transferred to military production. At the same time, there are a number of artificial statistical effects that create the impression that the economy as a whole is growing.
The fact is that it is not growing. In fact, two processes are taking place in the economy: a decline in people’s standard of living and a decline in consumption – in both the quantity of goods consumed and the quality of goods consumed. This is how the war is being financed.
“What is happening is not development, but a shifting of resources within the economy.”
An airborne artillery unit, March 2022. Source: Wiki Commons
In my view, the report by Aleksashenko, Inozemtsev and Nekrasov does not critically approach the official statistics. And because of this, we get a statistical illusion.
Personally, I find the simplest and most abstract argument more convincing. If my colleagues are right and the Russian economy is really growing, if we take all these figures on faith, then we get something strange: you can take a working economy, remove a million people from the workforce – 500,000 for the war, 500,000 as emigrants – increase the costs of all transactions – because, owing to the chain of intermediaries, each transaction abroad now costs more and gets you less – and the end result is an economy producing more.
This contradicts what we know about the functioning of an economy. There is no such thing as pressing a button and producing more. Especially if your costs have increased. You can also imagine a situation where you press a button and produce more now at the expense of tomorrow, but my colleagues do not expect a downturn tomorrow. Their report leads to the absurd conclusion that there is a magic button that increases output just like that.
So we need to look for where the numbers are deceiving us. We must understand that any statistic, even seemingly those that come from direct observation (for example, prices), is the result of complex mathematical models, which take inputs and spit out macroeconomic aggregates.
These models are calibrated and work well when the economy is in something like a steady state. When there are big structural shifts in the economy, however, that’s when those employing these models for estimates have a lot of leeway.
I do not think that the people sitting at Rosstat are deliberately tweaking the numbers. But it would not be surprising if you, presented with the opportunity to decide, roughly speaking, how to calibrate a model, you did it in such a way that it gave you the most favorable numbers.
Recently, the Stockholm Institute of Transition Economics released a report looking at what happens to Russian macroeconomic aggregates when we assume that the official estimates of just one parameter – inflation – are incorrect.
Personally, I find the simplest and most abstract argument more convincing. If my colleagues are right and the Russian economy is really growing, if we take all these figures on faith, then we get something strange: you can take a working economy, remove a million people from the workforce – 500,000 for the war, 500,000 as emigrants – increase the costs of all transactions – because, owing to the chain of intermediaries, each transaction abroad now costs more and gets you less – and the end result is an economy producing more.
This contradicts what we know about the functioning of an economy. There is no such thing as pressing a button and producing more. Especially if your costs have increased. You can also imagine a situation where you press a button and produce more now at the expense of tomorrow, but my colleagues do not expect a downturn tomorrow. Their report leads to the absurd conclusion that there is a magic button that increases output just like that.
So we need to look for where the numbers are deceiving us. We must understand that any statistic, even seemingly those that come from direct observation (for example, prices), is the result of complex mathematical models, which take inputs and spit out macroeconomic aggregates.
These models are calibrated and work well when the economy is in something like a steady state. When there are big structural shifts in the economy, however, that’s when those employing these models for estimates have a lot of leeway.
I do not think that the people sitting at Rosstat are deliberately tweaking the numbers. But it would not be surprising if you, presented with the opportunity to decide, roughly speaking, how to calibrate a model, you did it in such a way that it gave you the most favorable numbers.
Recently, the Stockholm Institute of Transition Economics released a report looking at what happens to Russian macroeconomic aggregates when we assume that the official estimates of just one parameter – inflation – are incorrect.
“It turns out that with relatively small adjustments to the model – just if inflation is, say, 15-17% now – everything that Aleksashenko, Nekrasov and Inozemtsev describe, all this economic growth, turns into a contraction.”
And then the picture becomes much more reminiscent of what I have described above, and what should be happening, when we calculate GDP, is a decline in production overall. There is a redistribution of resources from consumption to military production, reducing people’s standard of living.
This is what happens if we change just one parameter that is used to calculate macroeconomic aggregates. In fact, there is a lot of evidence, direct and indirect, that says that this is indeed the case, that inflation is higher.
Firstly, we see inflation in certain product categories running much hotter than the official figures. Secondly, we see what the Russian Central Bank is doing, which reports annual inflation at 9% but has raised its key rate to 21%. That is unheard of.
It turns out that either the key rate is completely ineffective as an instrument of monetary policy, i.e., it means nothing, or we have a radically incorrect idea of what inflation is currently, and it is actually 15-17%. In that case, the whole picture begins to come together; one thing begins to fit with the other.
If we roughly assume that inflation is actually underestimated by about half, then GDP growth disappears, as does the growth of real incomes that Aleksashenko, Inozemtsev and Nekrasov write about and that obviously does not exist. Because if this growth were real, we would have no idea where these real incomes are going, as there is no consumption growth in any data.
[In the report] they paint a mystical picture where real household incomes are growing, but households are not spending this money anywhere. And from all the other data we see that they are not saving it. But if inflation is higher, then these real incomes disappear, because they do not really exist.
This is what happens if we change just one parameter that is used to calculate macroeconomic aggregates. In fact, there is a lot of evidence, direct and indirect, that says that this is indeed the case, that inflation is higher.
Firstly, we see inflation in certain product categories running much hotter than the official figures. Secondly, we see what the Russian Central Bank is doing, which reports annual inflation at 9% but has raised its key rate to 21%. That is unheard of.
It turns out that either the key rate is completely ineffective as an instrument of monetary policy, i.e., it means nothing, or we have a radically incorrect idea of what inflation is currently, and it is actually 15-17%. In that case, the whole picture begins to come together; one thing begins to fit with the other.
If we roughly assume that inflation is actually underestimated by about half, then GDP growth disappears, as does the growth of real incomes that Aleksashenko, Inozemtsev and Nekrasov write about and that obviously does not exist. Because if this growth were real, we would have no idea where these real incomes are going, as there is no consumption growth in any data.
[In the report] they paint a mystical picture where real household incomes are growing, but households are not spending this money anywhere. And from all the other data we see that they are not saving it. But if inflation is higher, then these real incomes disappear, because they do not really exist.
In 2024, Russian oil companies have increased oil exports to China via the Northern Sea Route (pictured) by 30%. Source: VK
The authors of the report make the following argument: the missing consumer goods are being supplied by China and India. Maybe not advanced technology, but mass goods. They buy the oil and gas that the Russian economy exports. In your view, can India and China, along with other countries of the “Global South,” really save the Russian economy amid Western sanctions and a lack of access to Western technology and markets?
Here, they make a logically false argument. Let’s say that some tanker with oil is now bought by China, but before it was bought, for example, by Germany. But when it was sold to Germany, there was also Chinese demand, right? The Chinese just offered a lower price – because if they had offered a higher price than the Germans, then the same tanker in 2019 would have gone to China or India and not to Germany or the UK. And if oil is not going to Germany now, it means that it is going to China at a lower price. The transaction costs have gone up.
Similarly, if we do some operation in cryptocurrency now, of course, this means that our operations that used to be done through Raiffeisenbank or Bank of New York have not disappeared. Rather this means that now we have to pay a little more for each one. Because if we paid less than before, back when we went through Western banks, then those payments would have been made not through Raiffeisenbank but through cryptocurrency.
Of course, the Russian economy has not collapsed, as some hotheads predicted; it has not gone away. But for each transaction, for each item, the costs have gone up.
Here, they make a logically false argument. Let’s say that some tanker with oil is now bought by China, but before it was bought, for example, by Germany. But when it was sold to Germany, there was also Chinese demand, right? The Chinese just offered a lower price – because if they had offered a higher price than the Germans, then the same tanker in 2019 would have gone to China or India and not to Germany or the UK. And if oil is not going to Germany now, it means that it is going to China at a lower price. The transaction costs have gone up.
Similarly, if we do some operation in cryptocurrency now, of course, this means that our operations that used to be done through Raiffeisenbank or Bank of New York have not disappeared. Rather this means that now we have to pay a little more for each one. Because if we paid less than before, back when we went through Western banks, then those payments would have been made not through Raiffeisenbank but through cryptocurrency.
Of course, the Russian economy has not collapsed, as some hotheads predicted; it has not gone away. But for each transaction, for each item, the costs have gone up.
“Every unit of Russian exports is sold for less than it was sold for before. Every unit of Russian imports is bought for more than it was bought for before.”
There cannot be more production in an economy with higher costs.
The authors of the report claim that one of the saving graces of the Russian economy is that it is predominantly a commodities-exporting economy – specifically it exports commodities that the global economy needs no matter what – which is why sanctions are less effective than they would otherwise be. Therefore, they conclude, Russia may get poorer, but there is no crisis in sight for 3-5 years…
Aleksashenko, Inozemtsev and Nekrasov are right that all this will not collapse on its own. The effects we are talking about, which I believe indicate an economic deterioration, are a couple percent, single percentage points. Maybe even 10%.
We have seen that GDP and other macroeconomic aggregates can halve in seven years – this was the case in the early 1990s. But did trams stop running? Did clinics stop working?
In other words, this alone does not lead to an economic collapse. I believe that [the authors of the report], for the sake of [making] their arguments, fundamentally miss the fact that there is a war going on now and that it is being financed by reducing the country’s standard of living.
So if there is anything to discuss, then the main parameter is how much people are willing to tolerate a decline in their standard of living. Unfortunately, here too, the answer is not what people who want an end to the war would like to hear.
The authors of the report claim that one of the saving graces of the Russian economy is that it is predominantly a commodities-exporting economy – specifically it exports commodities that the global economy needs no matter what – which is why sanctions are less effective than they would otherwise be. Therefore, they conclude, Russia may get poorer, but there is no crisis in sight for 3-5 years…
Aleksashenko, Inozemtsev and Nekrasov are right that all this will not collapse on its own. The effects we are talking about, which I believe indicate an economic deterioration, are a couple percent, single percentage points. Maybe even 10%.
We have seen that GDP and other macroeconomic aggregates can halve in seven years – this was the case in the early 1990s. But did trams stop running? Did clinics stop working?
In other words, this alone does not lead to an economic collapse. I believe that [the authors of the report], for the sake of [making] their arguments, fundamentally miss the fact that there is a war going on now and that it is being financed by reducing the country’s standard of living.
So if there is anything to discuss, then the main parameter is how much people are willing to tolerate a decline in their standard of living. Unfortunately, here too, the answer is not what people who want an end to the war would like to hear.
“We know from the 1970s, 1980s and 1990s that people can put up with a lot for a long time.”
Before my eyes, from the age of 10 to 18, we went from queues for quality products to queues for butter, and then to queues for eggs and bread.
Even before the war, I had come to understand the difficulty of explaining why “things are bad and headed in the wrong direction” and “a collapse is inevitable tomorrow” are two completely different things.
The report claims that the sanctions are not very effective, but if they had encouraged the outflow of capital and labor from Russia, everything would have been much better. Do you agree with this?
I do not think it’s possible to assist the brain drain more than it has already been assisted. Some outstanding people remained in Germany under Hitler. Some remarkable people remained in Russia during the Civil War and under Lenin.
People stay. There are those who cannot be lured abroad. Still, the war and repression have led to an incredible outflow of people from Russia. In the first year of the war, twice as many Russians fled as in any year of the 1990s. I do not know what would have to happen to Russia for more to flee.
Even before the war, I had come to understand the difficulty of explaining why “things are bad and headed in the wrong direction” and “a collapse is inevitable tomorrow” are two completely different things.
The report claims that the sanctions are not very effective, but if they had encouraged the outflow of capital and labor from Russia, everything would have been much better. Do you agree with this?
I do not think it’s possible to assist the brain drain more than it has already been assisted. Some outstanding people remained in Germany under Hitler. Some remarkable people remained in Russia during the Civil War and under Lenin.
People stay. There are those who cannot be lured abroad. Still, the war and repression have led to an incredible outflow of people from Russia. In the first year of the war, twice as many Russians fled as in any year of the 1990s. I do not know what would have to happen to Russia for more to flee.
“Russia has experienced a brain drain that is unprecedented for any country in the last half century.”
Sure, there were larger waves of emigration from Syria and Venezuela, but the quality of human capital there was not the same.
Regarding capital flight, we also need to understand what it means to “encourage capital flight.” Those who talk about this have a simple scheme in their head: we have some Russian oligarch who made some dollars, and if he had the opportunity to invest them somewhere in the world, he would, for example, buy real estate in Courchevel or General Electric shares in the US. But instead, he returns the money to Russia.
But what exactly does he return? He cannot invest in General Electric stock, and he returns the money to Russia. But bringing dollars to Russia is an act that has no macroeconomic consequence.
Dollars only make sense if our oligarch bought some goods abroad and brought them to Russia. In this case, the dollars are put to work. And what would our hypothetical oligarch invest in if he were allowed to? In the most profitable business today: circumventing sanctions. This is where the biggest margins are now. Allowing Putin’s oligarchs to invest money abroad now, allowing capital flight, would amount to subsidizing the most profitable business out there.
In your view, how accurate are the report’s forecasts that there will not be an economic crisis in the next 3-5 years and that the existing economic model will not experience any shocks in the next 5-6 years?
Regarding capital flight, we also need to understand what it means to “encourage capital flight.” Those who talk about this have a simple scheme in their head: we have some Russian oligarch who made some dollars, and if he had the opportunity to invest them somewhere in the world, he would, for example, buy real estate in Courchevel or General Electric shares in the US. But instead, he returns the money to Russia.
But what exactly does he return? He cannot invest in General Electric stock, and he returns the money to Russia. But bringing dollars to Russia is an act that has no macroeconomic consequence.
Dollars only make sense if our oligarch bought some goods abroad and brought them to Russia. In this case, the dollars are put to work. And what would our hypothetical oligarch invest in if he were allowed to? In the most profitable business today: circumventing sanctions. This is where the biggest margins are now. Allowing Putin’s oligarchs to invest money abroad now, allowing capital flight, would amount to subsidizing the most profitable business out there.
In your view, how accurate are the report’s forecasts that there will not be an economic crisis in the next 3-5 years and that the existing economic model will not experience any shocks in the next 5-6 years?
Izmailovsky Market, Moscow, 1993. Source: Social Media
I believe there is no iron connection between the economy and political problems: the economy collapses, then the political regime collapses – it does not work like that. In the final analysis, an economic collapse is always connected with the actions of the political regime itself. For example, the USSR had major fiscal problems in the last two years before its collapse in 1991, as described in Yegor Gaidar’s book, Collapse of an Empire. But if at that time a political decision had been made to slash spending on the military-industrial complex, which was actually killing everything, and stop using hard currency to purchase machine tools and production lines for industry, then the budget problems would have been solved.
It would have been a short-term solution, it would not have been a reform, but what directly brought down the Soviet economy and the Soviet Union would have been avoided by this decision.
In the same way, if in December 1916 the Tsarist government had decided to get out of the war, Russia would have survived. There would have been many problems, protests and all that, but ultimately economic problems are the outcome of decisions made by a political regime.
Now, the decision is to continue the war in Ukraine. This decision can be reversed. But if it is not reversed, then I think a crisis and the end of the regime might come about even earlier. If the course is changed, then this might continue for decades.
So, if Donald Trump really manages to make a deal and conclude at least a Korean-War-like ceasefire, if not a peace agreement, then this will prolong the days of the Putin regime?
If Putin today decisively carries out demilitarization and reduces spending on the security services and propaganda, then yes, he can prolong the life of his regime. But if, for example, next year he increases military spending and increases spending on the security services and propaganda, then he might bring it all down in a year.
It would have been a short-term solution, it would not have been a reform, but what directly brought down the Soviet economy and the Soviet Union would have been avoided by this decision.
In the same way, if in December 1916 the Tsarist government had decided to get out of the war, Russia would have survived. There would have been many problems, protests and all that, but ultimately economic problems are the outcome of decisions made by a political regime.
Now, the decision is to continue the war in Ukraine. This decision can be reversed. But if it is not reversed, then I think a crisis and the end of the regime might come about even earlier. If the course is changed, then this might continue for decades.
So, if Donald Trump really manages to make a deal and conclude at least a Korean-War-like ceasefire, if not a peace agreement, then this will prolong the days of the Putin regime?
If Putin today decisively carries out demilitarization and reduces spending on the security services and propaganda, then yes, he can prolong the life of his regime. But if, for example, next year he increases military spending and increases spending on the security services and propaganda, then he might bring it all down in a year.
Share this article
Read More
