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June 25, 2008



My main concern about the Russian economy is that it seems to be becoming ever more oil export dependent. The state reaps most of the oil profit, which it then doles out to the escalating numbers of public sector workers. I wonder if Russia might be falling under a mild resource curse with the possible danger of Dutch disease. This latter, of course, seems less likely given what remains relatively low per capita GDP.

Nathan Smith

Yes... but what *is* Dutch disease? That's actually a lot of what I'm working on this summer... I don't think it's very well understood. There's an empirical regularity which is strong yet can be challenged from a number of angles, and a lot of theoretical stories, most or all of which (a) do not explain why Dutch disease deserves to be characterized as a "disease," and/or (b) have little empirical support. Of course the rising real exchange rate undermines the competitiveness of the Russian tradable sector, but what's wrong with that, when they have enough money to buy lots of imports, and when booming construction and retail sectors are generating plenty of jobs? And yet of course it's true that Russia might be headed towards an economic crisis in the medium term, and that there's rising inflation... as usual, as Churchill said, "I cannot forecast to you the action of Russia. It is a riddle, wrapped in a mystery, inside an enigma..."


I'm certainly no expert, but it certainly seems that if one particular industry crowds out the rest it increases volatility without improving long term incomes, in much the same way that purchasing a particular stock rather than a basket of stocks raises risk without raising average returns. The reason I tend to doubt it could apply in Russia's case is because it seems like their economy has plenty of room for expansion without crowding (via rising real prices) much out.

Nathan Smith

Well, *volatility* is not, in the strictest terms, a canonical Dutch disease story, but certainly it's part of the natural resource literature. But, first, you can't say:

"if one particular industry crowds out the rest it increases volatility without improving long term incomes..."

Because it *should* increase long-term incomes, since the particular industry that's growing-- in this case, not growing in terms of physical production, but growing in terms of income because of a favorable terms of trade shock-- doesn't need to absorb a lot of labor, or even all that much capital, but basically involves getting a lot of rents; almost a "foreign exchange gift" as some of the literature puts it. The oil industry is not crowding out "the rest" of *industries,* but rather (to some extent) the rest of the *tradable sector,* while the non-tradable sector booms all the more because of the added spending.

Yes, there's an increase in volatility because the net present value of the economy's wealth is highly subject to fluctuations in the oil price. But it's possible to mitigate (or even, in principle, entirely eliminate) one's exposure to oil-price risk by buying foreign stocks and securities, either through a Stabilization Fund administered by the central government (this is being done already, though perhaps not to an adequate degree) or through private-sector portfolios (also happening but probably much less than optimally).

It's not obvious that the Russian economy has "plenty of room for expansion" right now. Labor markets are quite tight. Perhaps their human capital is underemployed in the sense that a lot of people could do smarter and more productive jobs. But that might require certain kinds of investment that are difficult to get in a poor institutional climate-- which points to another possible Dutch disease story.

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