A session of the Russian State Duma in Moscow in 2005.
Photo: Dmitry Dukhanin
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Inflated Demand
The Russian economy has big problems: inflation in the first half of this year exceeded 5%. According to Vlast columnist Sergei Minaev, the underlying cause of the problem is the ambition of the Russian government to improve the standard of living for its citizens by increasing government spending.
Despite the various pieces of legislation adopted last week by the State Duma, primarily the three-year budget, that are aimed at putting a significant chunk of money into the pocket of the average Russian, Russians themselves remain largely dissatisfied with the state of affairs when it comes to their incomes. In particular, pensioners are quick to point out that a pension increase of just over 200 rubles a month is not even sufficient to cover the cost of inflation.
Of course, ordinary citizens are rarely satisfied with expanded government spending programs. If the government announces that it intends to give people more money, they presume that the offers should be generous, and people never believe that the government has increased its handouts sufficiently. When in 1966 American president Lyndon Johnson announced the US government's first really far-reaching program of social spending, under the slogan "guns and butter," Americans immediately protested that while the military budget increased dramatically, social expenditures were significantly less than had been promised.
In the US in 1966 the level of inflation was so low as to be almost unnoticeable. When a noticeable level of inflation does exist, however, people tend to see any addition to social spending as nothing more than compensation for the growth of consumer prices, and insufficient compensation at that. The situation is further complicated by the fact that when a government moves to combat inflation, one of its first steps should be to decrease rather than increase budget expenditures. By 1979, the "guns and butter" policy had brought America to the point where annual inflation hit 13% - an unbelievable number by American standards. Eventually, in 1980 US president Jimmy Carter was obliged to slash government spending.
In general, the situation is a vicious circle. Governments increase social spending to satisfy their citizens, but people are still often dissatisfied because rising inflation encourages them to believe that increased government expenditures on social programs are never enough. Meanwhile, social spending cannot be given free rein to increase without limit, since that leads to higher inflation and makes people even more disgruntled.
A significant decrease in inflation would help matters immensely, but it is almost impossible to achieve. In the first half of 2007, consumer prices rose by 5%, and the increase is calculated to be significantly more than 10% annually. According to a survey of the Russian economy over the period from January-May 2007 written by the Trade and Economic Development Ministry, "since the beginning of the year, inflation has been 4.7%, versus 5.9% a year ago. The lower level of inflation [observed] this year continues to be influenced by a growing supply of goods, particularly imports (imports rose 53.5% between January and April of this year), and by increased competitiveness (particularly in pricing) that is tied to the strengthening exchange rate of the ruble. At the same time, however, since March the rate of inflation has ceased to decline, and in April and May inflation (1.2%) exceeded last year's figure for the same period (0.8%). This is particularly due to pressure from the growing supply of money, which has been increasing since the middle of the first half of 2006 (in particular, for January-April 2007, the speed of the increase was twice as high as it was a year ago)… The 1% growth in prices for foodstuffs in May was fundamentally linked to higher prices for fruits and vegetables. One of the consequences of the ban on foreigners working as sellers in the markets, which went into force on April 1, is that fewer vegetables are being imported (despite lower import tariffs). Overall, in May prices for fruits and vegetables rose by 7.8% (by 3.2% and 3.1% in March and April, respectively). Since the beginning of the year, the rate of price growth has been gradually approaching last year's … The rate of price growth for non-food items in the current year remains at last year's level as a result of increasing demand among the population: growth was 0.4% in May, and overall since the beginning of the year, it is 1.9% (a year ago it was 2%), despite a significant growth in imports."
It turns out that the goal of decreasing inflation is being aided only by imports. Everything else, whether increasing the supply of money or even forbidding foreigners to work in retail, only makes matters worse. The worst offender is the continued high demand from Russia's citizens for all kinds of goods – foodstuffs and non-food items, imported and domestically-manufactured. And demand is growing because Russians' incomes are growing: as the Trade and Economic Development Ministry's report notes, "high levels of consumer demand continued in January-May 2007, supported by a rapid growth in the population's real disposable income in conjunction with an even more rapid growth in real take-home pay. The gains were 12.0% and 17.9%, respectively, in comparison to 8.9% and 11.4% in January-May 2006."
This is reminiscent of the US in the 1980s, when the government was at a loss to explain why inflation, in defiance of any and all strict budgetary and fiscal policy, could not be curbed to anywhere lower than the magic threshold of 9-10%. Eventually, it was decided that the problem was the population's growing incomes, which, for example, grew by 10.5% in 1979, and the people's stubborn desire to spend money today, under the assumption that things will only be still more expensive tomorrow.
It's a frustrating conundrum with no clear way out: the same population that complains that their incomes are not growing fast enough to compensate for inflation is guilty of perpetuating that inflation with their avid striving for a better life.
Sergei Minaev
All the Article in Russian as of July 09, 2007
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