Moscow is the richest nation now

Russia

Gunter Deuber

In Vienna, Gunter Deuber heads the economic analysis of Eastern Europe at Raiffeisen Bank International AG, one of the largest foreign banks in Russia and therefore not only active in Moscow.

Russia's prosperity is concentrated in a few regions. 10–15 of the over 80 regions are significantly richer than the national average, while the majority of Russia's regions are characterized by a regional gross domestic product (GDP) per capita or an income level that is well below the national average. In recent years, the extreme differences in GDP per capita have leveled out slightly. This trend is mainly due to declining values ​​in the richest regions and less to the fact that the poorer regions are growing faster and catching up. The extreme differences in income mean that a region like Moscow has an absolute nominal GDP (in US dollars or euros) that is comparable to that of a smaller affluent Western European country (such as Austria or Sweden) or a larger, emerging EU country such as Poland . In this respect it becomes clear why Russia is an interesting market for many international companies - with a focus on Moscow and perhaps a few other richer regions. However, business people in the country should not overlook the fact that the extreme regional differences in prosperity also harbor some potential for social and political conflict. In addition, the indebtedness of many regions is increasing significantly, given the central government's strong focus on fiscal consolidation. In two to three years, some regions of Russia could be so over-indebted that they could face liquidity and solvency problems.

Poverty is at home in many regions of Russia. (& copy picture-alliance / dpa)

The relevance of the discrepancy

The regional GDP and income data of Russia illustrate the extent of the income disparities between the 85 federal subjects of Russia (including the internationally unrecognized incorporation of the Republic of Crimea and the city of federal importance Sevastopol). They confirm the concentration of wealth in very few regions. Nonetheless, the figures allow a rather cautious interpretation, namely a (long-term) trend towards a certain convergence in the living standards in the regions of Russia (i.e. the levels of GDP per capita or income). Other studies, on the other hand, such as the OECD or some Russian scientists, do not see any tangible or empirically verifiable significant convergence of regional GDP and income levels in Russia from a longer-term perspective, and in some cases even see a trend towards increasing divergence.

Reducing regional income disparities is of both academic and practical relevance. Up until the global economic and financial crisis in 2008/2009, Russia had a very high average annual GDP growth rate (approx. 4–6 percent). The average income level, measured as GDP per capita for the country as a whole, has risen considerably and has thus exceeded critical development thresholds. Some economic theories (such as the thesis of Simon Smith Kuznets) would lead us to expect from a certain level of development that even the very unequal (regional) incomes will become more equal, or that the considerable income disparities will decrease. This expectation is based on the assumption that, ideally, in a development or industrialization process, the (regional) income differences in a country initially increase and then decrease again. Traditional convergence theories also suggest that in the event of a certain macroeconomic stabilization (which has been observed in Russia in recent years), clearly poorer regions should grow faster than richer regions.

The discrepancy in regional living standards in a highly centralized, territorial state like Russia is also an important political and economic issue. For business people in Russia, an understanding of the considerable regional income discrepancies and their implications and trends is of considerable relevance, since different market segments require differentiated regional market strategies. A business model that works in the very affluent Moscow or Saint Petersburg cannot necessarily be replicated in the rest of the country. Economic actors whose goal is to develop the domestic market away from the two megacentres Moscow and Saint Petersburg must be able to differentiate prosperous or emerging regions - of which there are a few - from less prosperous regions in order to survive successfully on the market.

From a political point of view, too great a regional income disparity can lead to considerable social and domestic political tensions. Due to the expectations of the population - especially the poorer population as well as in the poorer regions - of government control options, a very high regional income disparity can even be rated as a policy failure. In this respect it is not surprising that in almost every federal state structure and also in Russia there is a more or less clearly defined policy goal of a certain leveling of regional living standards. This is regularly formulated particularly explicitly in Russia, including for the Far East.

Regional prosperity and income trends

The development of the regional distribution of wealth and income in Russia can be divided into two phases. Between 1998 and 2006, especially after the end of the deep restructuring recession of the 1990s (which culminated, among other things, in the economic and financial crisis of 1998/1999), the regional income differences between the regions of Russia increased significantly (measured in terms of GDP per capita in Ruble). While regional GDP per capita in the poorest region was around 6 percent of the GDP per capita in the richest region in 1998, it was just 2.4 percent in 2004 and only 2.6 percent in 2006. Since 2006 this ratio has improved slightly in favor of the poorer regions and in 2012 was again just over 5 percent. The development of regional GDP per capita in the poorest region compared to the Russian national average shows the same development. In 1998 this figure was 20-25 percent, in 2004 and 2006 it fell to values ​​of 15 percent (in 2004 and 2006). Since 2008, this figure has again reached a little more than 20 percent.

In view of the outlined development over time, it becomes clear that the GDP per capita divergence between poor and rich regions in Russia has moved apart, especially in the extreme raw material-driven boom years, while it has been slightly above all since the crisis years 2008/2009 and also now going back. However, this latest trend towards convergence is mainly influenced by the loss of GDP and prosperity in the richest regions, which are more affected by financial market turmoil and thus also by the fall in commodity and asset prices; it is less a matter of significant GDP growth (i.e. catching up) in the regions with very low GDP per capita levels. The current environment of macroeconomic weakness (2014 will be a year of macroeconomic stagnation, mainly driven by declining investments) and the recent pressure on asset prices in Russia could again particularly affect the more affluent regions and thus, statistically speaking, the less developed regions compared to them somewhat better let stand there. Whereby this would then again not be a sustainable catch-up for the poorer regions, but merely a consequence of the risks of the one-sided economic structure and extreme concentration of prosperity in Russia.

Regional diversification and income level in an international comparison

The extreme measure of the differences between the poorest and richest regions in Russia is distorted by extreme values ​​in both directions. The extremes upwards are mainly represented by the Moscow metropolitan region and some raw material extraction areas in the Urals and the Far East (Magadan, Sakhalin and Tyumen regions, the Komi and Republic of Yakutia (Sacha) republics, the Chukchi autonomous district); while the extremes downward include provinces such as the republics of Dagestan, Tywa, Adygea, Altai, Ingushetia, North Ossetia-Alania, Chechnya and Kabardino-Balkaria, and the Ivanovo region.

Translated into absolute income levels, the extreme prosperity discrepancies outlined above mean: The per capita GDP of 2012 in the few very prosperous regions of Russia (at purchasing power parities) was roughly on the average level of the EU (around 30,000 US dollars), in individual raw material regions even reached values ​​of 40,000 US dollars or more, while the arithmetical average per capita GDP of the remaining regions of Russia in 2012 was on average about the level of a country like Egypt or the Ukraine (4,000 to 6,000 US dollars). The poorest regions of Russia (for example Dagestan, North Ossetia-Alania, Tywa) naturally show even lower values ​​(around 2,000 US dollars). On the basis of the prosperity levels outlined, it is also clear that a region like Moscow (with around 11 million inhabitants) has an absolute nominal GDP (in US dollars or euros) that is similar to that of a smaller affluent Western European country such as Austria, Belgium or Sweden or can be compared with that of a larger, up-and-coming EU country such as Poland. In this respect, it also becomes clear why Russia is a very interesting market for many international companies, with a focus on Moscow and possibly a few other richer regions - despite the considerable income differences to the rest of the country. Especially since the clear tendency towards demonstrative consumption and thus high-priced goods is higher in Moscow than in Austria or Sweden.

A broader approach to measuring regional differences in GDP per capita reinforces the picture. The average GDP per capita of the five poorest regions in relation to the five richest regions is also only around 9 percent, the average GDP per capita in the ten poorest regions is only around 15 percent in relation to the ten richest regions. The income disparities in Russia are also very high by international standards. The ratio of GDP per capita in the poorest and richest regions of the country is in hardly any other important emerging country at such a low level as in Russia. It is therefore not surprising that a more complex statistical measure such as the regional Gini coefficient, which measures the gap between rich and poor regions, is at the highest level in Russia compared to other (emerging) countries with a comparable level of development. In a comprehensive comparative study by the OECD, Russia has a Gini coefficient of 0.47 for 2007 (the Gini coefficient is between 0 and 1, where 0 means equal distribution and 1 means extremely unequal distribution). All possible comparison countries - with some significantly lower income levels - have values ​​below 0.40: India with 0.39, Mexico with 0.38, China and Brazil with 0.3 or Turkey and South Africa with values ​​of 0.25 and 0 , 24. For comparison: In Germany, the regional Gini coefficient is 0.12. Even in a raw material country like Chile, which is characterized by extreme social and regional inequalities, the regional Gini coefficient is 0.35. In other words, at the current income level, Russia's regional Gini coefficient should be significantly lower, around 0.3 to 0.35. Especially since the regional Gini coefficient in Russia tended to deteriorate in the period from 2000 to 2007/2010 (where the last reliable, comparable international data is available).

There are still extreme differences in income - not just between the regions

The extreme concentration of wealth in Russia in a few places becomes clear when one compares the population shares of the regions with their share in the (aggregated regional) GDP of Russia. About 8 percent of Russia's population (or just under 8 percent of households) live in the capital Moscow, while Moscow's regional GDP is just over 20 percent of Russia's GDP. This means that Moscow's regional GDP per capita is around 270 percent of the national average in Russia and the median income in Moscow is a high 220 percent of the median income of all regions in Russia. In contrast to regional GDP per capita, the regional median income also takes account of transfer payments made by Moscow to regional budgets. Therefore, the median income in the economically weaker regions, in relation to the national average, is mostly above the regional GDP per capita (in relation to the national average). Therefore, the regional discrepancies in Russia - measured in terms of regional median income - are somewhat smaller than in regional GDP per capita. In addition, from a purely statistical point of view, the median income of a region is less dependent on individual outliers within the regions. The figures also show that some of the extraordinary regional economic divergences in Russia are (still) partially offset by transfers. The regional discrepancies in other practically relevant economic indicators (e.g. in per capita sales in retail) remain high despite transfers. The levels of 270 percent of per capita GDP in Moscow compared with the national average (or 212 percent and 204 percent for median income and retail sales compared to the national average) again point to the extreme concentration of prosperity there. In a way, the latter also reflects extreme "wage inflation". For example, senior executives at western companies in Moscow often earn many times that of their colleagues in other, also much more affluent countries.

The extreme concentration in Moscow already implies that, among the 30 most populous regions, only four other regions have a share of GDP above the share of population. For the rest of the more than 70 regions of Russia, the share of GDP is sometimes more or less significantly below their share of the population. This gives a dramatic picture in terms of the regional GDP distribution for Russia. Over 50 percent of the regions (around 40 regions) have a regional level of GDP per capita that is only around 50–70 percent of the national average, while ten to eleven regions have an extremely above-average regional GDP. A total of 64 regions in Russia have a regional GDP below the national average, 18 regions have a GDP above the national average. This includes 82 regions for which there are reliable long-term time series for important economic indicators, including the comparisons made below. There are no reliable long-term time series for the autonomous district of the Khanty and Mansi as well as the Yamal-Nenets and for the Kamchatka region. This is partly due to administrative reclassifications.

The regional data on per capita retail sales are characterized by almost the same regional disparity as the data on GDP per capita. According to the 2012 data, 66 regions of Russia have retail sales below the national average, and only 16 above the national average. This seems logical, because higher-priced offers are only in demand once a certain basic level of consumption has been satisfied, while in other regions retail sales hardly exceed basic consumption. However, in terms of retail sales per capita, the absolute difference between poorer and richer regions is at least somewhat smaller than in terms of GDP per capita, which suggests certain compensatory effects (e.g. via transfer payments). The sketched picture can also be seen from the fact that the regions with a GDP per capita with a value below the national mean show an average difference of 30 percentage points to the average; for median income the value is 13 percentage points, but for per capita retail sales the difference to the national average is again 24 percentage points. The regional minimum values ​​compared to the national average are around 20 percent or less for GDP per capita, 60 percent for median income and just under 20 percent or slightly more for per capita retail sales.

Reasons for the course of the divergences

Overall, the extreme regional disparities in Russia are partly due to a plausible historical and geographical concentration. The concentration of raw material extraction in the Ural region, the concentration of the population in the European part of Russia (around 70 percent of the population live on 25 percent of the land area, and that mainly in western parts of the country) or the concentration of administration and business life in Moscow should be mentioned here. However, the extremely weak catching-up of the less developed regions of Russia over the past few years should not obscure the fact that there are apparently deeper economic, structural and institutional reasons for the considerable income disparities in Russia - both between the regions and within the regions.The diversification and modernization of the Russian economy, which has so far been unsuccessful, is certainly not conducive to a broader convergence of regional levels of prosperity (pensions from the raw materials sector usually have very little broader economic spill-over effects within a region and on to neighboring regions, for example for further investments in other sectors). In addition, general institutional weaknesses in Russia certainly also hinder a broader distribution of wealth. Important public goods (such as infrastructure, education) are neither efficiently nor evenly provided in the regions.

The trend of increasing and then decreasing regional income divergence in Russia is not necessarily characterized by a structural further development process, as would be justified by increasing modernization and industrialization (as assumed by the Kuznets thesis). Rather, the development can be explained by the absolute and relative declining income level in the (raw material) boom regions since 2008/2009, which means that the poorest regions have at least statistically been able to catch up. However, the poorer regions have not developed any further. In this context, it should be emphasized that the weak regional GDP and income development compared to the national trend is not limited to individual disadvantaged "peripheral regions" in Russia. Among the 30 most populous regions in Russia, i.e. regions each with at least one percent of the total population, there are a number of regions that show a significantly disproportionate development compared to the richest regions or the national average. Among the regions with a significantly below average development of GDP per capita are not only clearly (economically) historically or geographically very peripheral regions, but also regions such as the areas of Tula, Rostov, Samara, Saratov, Irkutsk or Novosibirsk (in some regions the still suffer today from the planned economy monostructural problems of the Soviet Union, for example with the sometimes extreme concentration in the arms sector).

Institutional reforms are necessary

With regard to its regional differentiation, Russia faces considerable challenges, which are exacerbated by the emerging short and medium-term rather weak macroeconomic development. And yet: A few Russian regions - apart from the traditional economic and raw material centers - show a more positive development than the overall trend outlined. In this context, reference is often made to regions such as the Kaluga, Ulyanovsk, Nizhny Novgorod regions. The positive development of around five to a maximum of ten regions above the national average is achieved through a better economic and investment environment compared to the terrifyingly poor national average. Some successful regions have fewer administrative hurdles, less corruption and an above-average training and qualification environment. However, such regional successes should be assessed with caution. As a rule, the successes in such regions are based on a committed local or city administration and, above all, the personal commitment of a few executives. However, such developments are in a sense the continuation of the personalized political system of the state as a whole at the regional level.

The outlined extreme regional economic disparities in Russia are confirmed by a trend that also applies to the country as a whole. In relation to the high average income level in Russia (well above that in other large emerging countries), the institutional quality of the country - which is usually also reflected in the extent of regional disparity in a country - is rather below the level in comparable economies . In addition, the significant regional income disparities are in some ways a reflection of the country's extremely centralized political system. This is because countries with a greater distribution of power in the country tend to have more balanced regional income distributions.

In addition, the relationship between the considerable regional income disparities and the increasingly disappointing macroeconomic development in Russia as a whole should not be neglected. More recent research work by the International Monetary Fund - certainly not an institution that hastily calls for redistribution - clearly shows that excessive (regional) inequality in a country inhibits long-term macroeconomic development from a certain level or a certain degree of equality above a certain level Level rather promotes steady growth.

The role of foreign companies and direct investment

The increasing expansion of some foreign companies, which are clearly focused on the domestic market of Russia, into the regions does not contradict the picture of the considerable and sometimes alarming income disparities in Russia. Most of the time, the regional strategies of foreign companies focus precisely on very few other regions or regional centers. Especially since some of the economically better developing regions of Russia are just developing in the wake of the large center of Moscow, which (in terms of gravitation theory) can be explained mainly by radiation effects and not necessarily only by special local conditions. Especially since the expansion of some companies into other regions of Russia is partly due to over-penetration in the very large metropolitan areas such as Moscow and Saint Petersburg. In this context, it should be emphasized that around 40–50 percent of foreign direct investments in Russia are concentrated in Moscow and Saint Petersburg and that these locations continue to be the most attractive for investors, although the investment conditions in some of the country's few economically successful regions are better.

High levels of new borrowing and debt dynamics could overwhelm regions

To date, the extreme regional differences in the economic power of the regions of Russia have (still) been partially offset by transfers. However, the (fiscal) redistribution leeway in Russia, for example through loans from the central government to the regions, in view of the weak macroeconomic growth and the clear political concentration of the government in Moscow on so-called "management" of the accumulated buffers at the central government level (i.e. the reserve fund and the high foreign exchange reserves, which are important buffers for Russia) in the coming years. This can be seen, among other things, in the clear desire to reduce central government loans to the regions in the coming years. Traditionally, fiscal policy would be an element in eliminating massive regional economic disparities. In this respect, it is not surprising that more and more tasks in the areas of social affairs, education or infrastructure are being transferred to the regions, which they cannot really shoulder because they lack adequate taxation options or alternative sources of income at the same time.

As a result, however, the indebtedness of the regions of Russia has increased significantly in recent years, starting from still low levels. Some of the larger and prosperous regions (which represent around 30–40 percent of the regions' borrowing) currently finance their borrowing primarily through ruble-denominated capital market instruments on the local bond market (mostly at moderate conditions and with longer terms). In contrast, the majority of the smaller and / or less prosperous regions of Russia (which represent around 60–70 percent of the regions' borrowing) are financed primarily through bank loans. The latter are usually rather short-term and already have quite high interest rates (especially compared to loans from the central government to the regions). In the current environment of interest rate volatility and rising interest rates in Russia, debt through short-term bank loans in particular harbors considerable short-term liquidity and interest rate risks for some regions. According to estimates from the financial industry and rating agencies, the indebtedness of the regions of Russia has more than doubled since the financial crisis in 2008/2009, from around 35 billion dollars to an estimated 78 billion dollars at the end of 2013. And if current trends continue, the indebtedness of the regions of Russia could Exceeding a level of 100 billion dollars in 2015 (around 5 percent of Russia's GDP or half of the central government's debt).

If the current debt dynamics continue, only around 15-20 out of 83 regions in 2015 and 2016 might be able to meet their financial obligations without significant ad hoc grants from the central government or debt extensions. In view of the collapse in corporate taxation expected in 2014, which on average accounts for around 25 percent of the income of the regions, ad hoc financial support for some regions could be necessary again in 2014. A regional fiscal policy, however, which primarily relies on short-term bank loans (often through state banks) and ad-hoc loans from the central government (which on average account for around 20 percent of the regions' income), the latter often in a rather intransparent and less institutionalized manner also does not appear to be a sensible framework for organizing a sustainable regional resource (re) distribution.

The increasing indebtedness of the regions of Russia is also - beyond the pure indebtedness problem - of broader economic relevance, since the regions themselves would have to close parts of the bottlenecks for further economic development of the whole country through investments, but many regions will probably be less and less able to do this in the future . Given the increasing ongoing financing needs of Russian regions, the ban on financing in the international capital markets could also be lifted (the regions were largely deprived of the possibility of borrowing abroad as a result of the 1998/1999 financial crisis). This endeavor is to be seen above all against the background that the regions of Russia could receive money on the international capital markets at slightly lower interest rates and with longer terms than on the local market. The requirements for the proposed criteria for the permission to take on foreign debts at the regional level (above all having a credit rating at the level of Russia, which is precisely supported by the buffers of the central government) are so strict that probably only five or six of the 85 Regions could be considered for this. With this measure, the discrepancy between the already developed regions and the rest of the country could widen even further. Especially since richer regions may have some potential for privatization in the coming years, which is not the case for the less developed regions.

Overall, new borrowing in the regions of Russia may become increasingly problematic in terms of its speed (not yet its level) in the coming years, as follow-up financing will of course also be required in the foreseeable future. Furthermore, financing through short-term bank loans increases the regions' dependence on their lenders - often the large state banks - which can certainly contain a political element; this is particularly true in the context of the significant economic downturn to be expected in 2014; the latter will weaken the income side of the regions (for example through corporate taxation) again. It should be noted here that, even in the context of the difficult economic situation in 2008/2009, the central government in Moscow (directly or indirectly) gained increasing influence at the regional level through non-transparent ad-hoc financial aid.

With regard to the increasing indebtedness of the regions of Russia, it should also be noted that the central government's policy, which is often aimed at "one-off effects" (e.g. through major events), implies considerable financing and, above all, maintenance expenditure for the regions. Debt expenditures in a region like Krasnodar rose from around 3 percent of income in 2009 to around 50–60 percent in 2013, among other things due to the Winter Olympics. For example, many of the Olympic expenses were financed by the state "Wneschekonombank" (VEB) and some of these commitments are currently being restructured. A development similar to that caused by Sochi in recent years threatens in the eleven host cities (or regions) of the soccer World Cup in four years (where Sochi will be there again). If the soccer World Cup costs approximately as much as comparable events in other countries, it could cost between 40–100 billion dollars, of which around 30–50 percent would then have to be financed by the regions. The 2018 World Cup could exacerbate the debt problem in the regions of Russia.

Political and economic implications of high income disparity

As shown in the present article, Russia's regions are characterized by extreme disparities in regional GDP per capita, which is in part easily offset by transfers, but is nonetheless reflected in relevant economic variables (such as regional per capita retail sales). Here the levels of the disparities are close to those for the GDP per capita values. The extreme differences in income in Russia have anything but trivial (socio-) economic and political implications. On the one hand, the income level in the few prosperous centers and regions is at an extreme level in relation to the level of development of the country. This can be of interest to economic actors targeting this purchasing power. However, market presentations and market strategies that work in the economic centers of Russia cannot simply be transferred to other regions. In addition, the sometimes very high income and wage levels in a few regions result in general wage pressure, at least in regions bordering the prosperous centers and regions, which is detrimental to the economic development of the country as a whole. For example, wage increases do not reflect productivity gains. In addition, the extreme economic and socio-economic disparities make it increasingly difficult for the less developed regions or their populations to connect to the significantly more developed regions and the population living there. Life expectancy in affluent regions such as Moscow or Saint Petersburg is currently over 70 years, while in the poorer regions of the country it is more or less just over 50 years. The labor market requirements in Moscow or the few other emerging regions of Russia (e.g. with regard to the required IT skills, foreign language level or general work and life attitude) are meanwhile such that many residents from the less developed regions of Russia can no longer meet them. This increasingly limits interregional mobility, which then increasingly means very limited intergenerational opportunities for advancement; this is a classic effect of a very unequal regional distribution of income and wealth. The outlined major socio-economic regional divergences in Russia thus harbor considerable potential for political mobilization, which to date has hardly been used in the politically very concentrated state.

Finally, with regard to political implications, it must be clearly pointed out that even the few economically more successful regions of Russia, despite a better institutional environment than the national average, can presumably only succeed in the existing political system. This makes it questionable whether the regions of Russia can really be viewed as the engine of modernization or of political and social change. This aspect is relevant because there have been some approaches in this direction in recent years, for example at the European Bank for Reconstruction and Development (EBRD) or within the framework of the "World Economic Forum", both of which, in some cases, also deal with such a forum Intention to have turned to the successful regions of Russia in a special way.

The present article represents the personal opinion of the author and not necessarily that of Raiffeisen Bank International.

Reading tips

Ahrend, Rudiger: Understanding Russian Regions ’Economic Performance during Periods of Decline and Growth. An Extreme Bound Analysis Approach, in: Economic Systems, 36.2012, No. 3, pp. 426-443

EBRD: Diversifying Russia. Harnessing regional diversity, Chapter 4: Improving the business environment in Russia’s regions, London, 2013, pp. 42–49

Guriev, Sergei, Elena Vakulenko: Convergence between Russian Regions [= CEFIR Working Papers No. 180], 2012

International Monetary Fund: Redistribution, Inequality and Growth. IMF Staff Discussion Note, February 2014

Kholodilin, Konstantin A., Aleksey Y. Oshchepkov, Boriss Siliverstovs: The Russian Regional Convergence Process: Where is It Leading? in: Eastern European Economics, 50.2012, No. 3, pp. 5–26

Lehmann, Hartmut, Maria Giulia Silvagni: Is There Convergence of Russia’s Regions? Exploring the Empirical Evidence, 1995-2010 [= OECD Economics Department Working Papers No. 1083], 2013

Yakovlev, Evgeny, Ekaterina Zhuravskaya: The Unequal Enforcement of Liberalization. Evidence from Russia’s Reform of Business Regulation, in: Journal of the European Economic Association, 11.2013, No.4, pp. 808-838