Russia's Growth Crisis: It's not the middle-income trap that Russians should fear. It's the Bear Traps

Russians and observers are concerned that Russia is in a growth crisis.  A recent article in Russia Today is typical:

The Russian economy will not be able to grow faster than 2 percent per year in the coming decade and might become another Greece, says one of Russia’s leading investment banking firms Renaissance Capital.

An underlying theme is that Russia is entering the Middle Income Growth Trap. The idea is that when countries reach an annual per-capita income of $15,000 in PPP dollars that growth significantly slows down. 

Fear of the middle income growth trap misses the point, however. Russian growth has slowed down not because the period of catch-up growth is over but because oil prices have stabilized. The reason why Russia grew so fast from 2000 to 2008 was the growth in oil prices. As oil prices grew Russia became much wealthier. Now that oil prices have stabilized this source of growth has receded. The slowdown we observe today is simply the expected outcome of the stabilization of oil prices. Growth rates have declined because the period of rising oil prices has ended. Russian growth rates have settled down to levels that are consistent with the non-oil fundamentals of the economy. It is only now that oil prices have stabilized that we can see how anomalous the high growth rates of the last decade were.

To the extent that the middle income growth trap is a real phenomenon, it is because that level of income reflects a certain degree of convergence to the technological frontier and therefore the steady-state growth rate. Absent the oil effect, Russia is not really at the middle income level. Its per capita GDP grew from $7,700 in 1999 to $15,100 in 2008. If we say the economy would have grown at 2% a year at a flat oil price, then it would have grown to $9,200 by 2008. So Russia is a $9,000 economy, that only resembles a $15,000 economy because of oil The middle income rule doesn't apply.

Now the fact that Russia's 2000-2008 growth was due to oil and not catch-up means there is more room for catch-up growth than one might otherwise think. That is good news, in one sense.

But the more fundamental point is that all during this period Russia's growth process has been hampered by the structural legacies it has inherited from the Soviet period, what Clifford Gaddy and I refer to (in our new book that has just appeared) as Bear Traps. These are primarily a spatial misallocation that imposes excess costs on production and investment; distortions to human capital; an excessively high relative price of investment that serves as a tax on physical capital accumulation; and an economic mechanism that inhibits adjustments that would correct the misallocation.

Because of the Bear Traps Russia cannot experience the same catch-up growth that a similar economy not so burdened would display. Russia must always invest more to get the same catch-up effect as other countries. Also, the existence of the Bear Traps keeps it from being able to implement the necessary institutional reforms it needs for effective catch-up. 

The emphasis on the middle income growth trap, and the reluctance to notice the impact of oil prices on Russian growth distorts analysis of Russia's growth crisis. It pushes attention away from dealing with the Bear Traps which is the only way to fundamentally alter Russia's growth trajectory.

But it should also be noted that oil has been good for Russia. Russians are much richer than they otherwise would have been. Yesterday's oil may have been a key enabling factor in creating the structural legacy that so burdens today's Russia. But wishing away today's and tomorrow's oil is stupid. Russia without oil won't be Sweden, or even Hungary or Poland. It won't even be Ukraine. It will be Ukraine with Russian-size Bear Traps. The only hope Russia has to deal with the Bear Traps is to take advantage of the oil and gas -- the Resource Track.

A Nightmare Ends (actually January 1, 2016)

The Great Nightmare will finally end. The USGA and the Royal and Ancient Golf Club of St Andrews have finally announced that they will implement the ban on anchored putting. Here is the USGA letter:

May 21, 2013 Dear USGA Member: The USGA cherishes its strong relationship with our Members, and we appreciate the support you provide in helping us lead the game toward a sustainable future. Your membership bolsters the critical mission of the USGA in many important ways and has helped to make the game more enjoyable for golfers of all ages and skill levels. Recognizing the role that you play in all we do to protect and nurture the game, we want you to be among the first to know about an important announcement. Last November, after an extensive review, the USGA and The R&A proposed Rule 14-1b, a new entry to the Rules of Golf that prohibits anchoring the club in making a stroke. This morning, together with The R&A, we are announcing the adoption of Rule 14-1b for players at all levels of the game, effective January 1, 2016. Final approval of Rule 14-1b follows a comprehensive and unprecedented process for playing Rules in which comments and suggestions from across the golf community were collected and considered. In our best judgment and having considered all of the input that we received, both before and after the proposed Rule was announced, we concluded that Rule 14-1b was necessary to protect the essential nature of the traditional method of stroke and eliminate potential advantages that anchoring the club provides. Throughout the game's 600-year history, the essence of the traditional method of golf stroke has involved swinging the club with both the club and gripping hands held away from the body, requiring the player to direct and control the movement of the entire club. Anchoring one end of the club against the body, and creating a point of physical attachment around which the club is swung, is a substantial departure from the traditional swing. Our judgment, based on tradition, observation and experience, is that anchoring creates an unacceptable risk of changing and reducing the challenge of making a golf stroke. The new Rule does not alter current equipment standards and allows for the use of all conforming golf clubs, including mid-length and long putters, provided such clubs are used in a non-anchored manner. The Rule narrowly targets only a few types of strokes in which the club is anchored, while preserving a golfer's ability to play with a variety of permissible gripping styles, putter types and swing methods. The effective date of January 1, 2016, at the start of the next four-year cycle for revisions to the Rules of Golf, provides an extended period in which golfers currently using an anchored stroke may adapt their method of stroke, if necessary, to conform to the requirements of the new Rule. We know that not everyone will agree with our final decision. However, we hope the new Rule will bring to a close the longstanding, controversial debate about anchored putting and its place in the game. Of equal importance, we hope that those who have expressed concerns know that they have been heard; can understand our reasons for concluding that Rule 14-1b is in the best interests of the game; and will now join with us in assisting any golfers who need help moving to a non-anchored stroke. Recognizing that you may have questions, and that you may also want to share this information with fellow golfers, we have developed videos, images, graphics and other materials that are available at www.usga.org/anchoring to help you become more familiar with the specifics of Rule 14-b. We have also provided a comprehensive document that explains the basis for our final decision and addresses the primary questions and concerns voiced by those who expressed opposition to the new Rule. Thank you for your support and passion for the game as we continue to serve all golfers around the world and work to secure the health and traditions of the game for current players and for future generations. Sincerely,
	Glen Nager President		Mike Davis USGA Executive Director
For the good of the game®

Unfortunately, the rule goes into effect only on January 1, 2016, but at least we know it will end.

This is a great day!

Energy Errors

Charles Mann has an interesting article on unconventional oil and gas in the Atlantic. Lots of good stories and  he cites Morris Adelman so it is a worthwhile article. But two glaring errors induce this post.

First, is this concept of EROEI. Let's quote Mann:

Economists sometimes describe a fuel in terms of its energy return on energy invested (EROEI), a measure of how much energy must be used up to acquire, process, and deliver the fuel in a useful form. OPEC oil, for example, is typically estimated to have an EROEI of 12 to 18, which means that 12 to 18 barrels of oil are produced at the wellhead for every barrel of oil consumed during their production. In this calculation, tar sands look awful: they have an EROEI of 4 to 7.

I am fully aware that some analysts use this concept, but I cannot believe that any economist would. The whole point of economics is to compare the value of inputs and the value of outputs. Not their physical unit measures. If you use lots of low-cost energy to create high value energy that is a good thing even if the quantity of the low-cost energy is huge. In this example, Mann talks about barrels of oil for barrels of oil. Sometimes the measure is in BTU's or some other physical unit, but the same error arises. We use coal to produce electricity because electricity is a more valuable type of energy -- try powering your ipad directly with coal.  Later in the article Mann talks about Econ 101, but if he took it he would not make this error.

Second, Mann goes on and on about the resource curse. The idea that resource abundance causes deteriorating economic performance has been much studied. But as Mike Alexeev and Robert Conrad clearly demonstrated it is an elusive curse. Alexeev and Conrad's paper should have ended these discussions, but they endure. This despite the fact that the empirical work that purports to find a resource curse is flawed for many reasons. But the most important is the failure to consider what the wealth of the country would be without the resources. That is correct, this is actually ignored.

To find the resource curse cross-country regressions are employed to explain growth performance. You always need some measure of initial GDP since growth slows down as you get richer. But most resource abundant countries discovered their oil before 1960 or 1970, the typical years used for initial GDP. So resource abundance led to higher GDP but its effect in the regression is explained by initial income not natural resource wealth (no matter how mismeasured -- I leave that for another time).

This fundamental error pervades the analyses. You typically find that a country like Russia has very high corruption for its level of GDP and this is explained by its resource abundance. But if Russia had less resources it would have much lower GDP! The reason Russia is off the regression line is not that its oil makes it more corrupt but that its oil makes it wealthier than its institutions and other fundamentals would suggest. Take away the oil does not make it richer!

Energy Independence and Analysis

The revolution in production of unconventional oil and gas in the United States is no doubt an important development for the economy. But it also has been accompanied by a lack of analysis. Case in point, Sunday's NYTimes piece on the "Dark Side of Energy Independence."  The authors, editors at Foreign Affairs, argue that increased US production could lead to a 50% reduction in oil prices, and then analyze the effects of this on oil producers elsewhere.  They point out that:

lower energy prices will undermine the stability of the Persian Gulf monarchies, whose hefty oil revenues have allowed them to win their populations’ loyalties through patronage and a lack of taxation. These countries do not always share American values or help advance American interests, but anything that destabilizes them would create problems that Washington could not afford to ignore.        

What is amazing about their argument is that they never consider how oil producers will react to lower oil prices. They do not consider the impact of $50 per barrel oil on the profitability of unconventional producers. If prices fall in half which oil projects are likely to be cut back? Presumably those with the highest costs. 

Nor do they consider how OPEC producers might react to this increase in oil production from elsewhere. They could, cut back their production, as comments from Saudi oil minister, Ali Naimi, suggests. But if OPEC cuts back then why would prices fall in half? Alternatively, facing lower prices desperate countries might increase production causing a further fall in prices, as Michael Levi notes. 

But the key point to remember is that unconventional production of oil and gas is a response to high oil prices. As prices fall the projects that are cut back are those that have the highest marginal cost. Failing to consider this is an invitation to faulty analysis.