January 22, 2003
Goldilocks and the Three [Russian] Bears
We all know the story of Goldilocks and the Three Bears. Papa bear's porridge was too hot, momma bear's porridge was too cold, and baby bear's porridge was just right. Papa bear's bed was too hard, momma bear's bed was too soft, and baby bear's bed was just right. And so on for every other thing in the Three Bears' house.
On January 16, 2003, a Reuters new story, dateline Moscow, reported an interview with the Moscow office head of the International Monetary Fund. He opined that high oil prices could hurt growth by driving up the value of the ruble (real appreciation of the ruble). An appreciating ruble would retard the development of import substitution industries and reduce the external competitiveness of Russian goods. In the same interview, he also opined that the economy could stagnate if crude oil prices fall. He did not state the price of oil that was just right, the price which would enable the economy to grow. That judgment is left to the reader.
Goldilocks has entered the Russian bears' house. High oil prices will harm growth. Low oil prices will harm growth. Only the right oil prices will foster growth.
In his "Metaphysics," Aristotle set forth the logic of reasoning. It consisted of the "law of identity," "the law of contradiction," and "the law of the excluded middle." The latter law states that a thing cannot be both A and not-A at the same time. Evidently logic is not in the toolbox of the IMF's Moscow office.
How can one maintain both positions about high and low oil prices harming growth at the same time?
The answer is that the IMF follows conflicting objectives. On the one hand, it seeks to avoid currency appreciation. On the other hand, it seeks to avoid current account deficits and budget deficits. On the one hand, high oil prices generate large foreign currency earnings, which, when converted into rubles, will cause inflation in excess of Russia's trading partners. The consequential real ruble appreciation is seen to increase imports and dampen exports, thus retarding domestic industry. This reasoning amounts to protectionism. On the other hand, low oil prices reduce export revenues, which, in turn, compress tax revenues and contribute to budget deficits and also may, as it happened in 1997-98, lead to current account shortfalls. This will make it more difficult to repay the IMF and service other foreign debt.
How can either of these developments affect growth of real output? The connection is not what the IMF claims. Import substitution only reshuffles domestic aggregate demand between industries and, by transferring resources into less efficient industries, actually reduces national value-added output (GDP). Lowering import substitution is good, not bad for the economy (see "Can More Liberal Subsidies Spur Growth and Reduce Inflation?") However, higher world oil prices can reduce global demand and oil production in high-cost countries such as Russia. But then Russia could indeed engage in more value-added production. This would mean real restructuring, due to high, not low oil prices, contrary to the IMF reasoning.
It is low world oil prices that may suppress growth in Russia under its current economic system. As we explained in several articles posted to this web site, high oil prices are neither necessary nor sufficient for growth in Russia. They are complementary to the Central Bank's fiscal policy of controlling tax remittance by exporters and, inadvertently, easing the payment jam. This, in turn, facilitates payment velocity and fosters output under available idle capacity. (See "New Data Confirms the Basic Relationships in the Russian Economy: Ten Years of the New Economic System Revisited.") All other things being equal, low world oil prices reduce export earnings and remittance inflow, which can slow down a timid Russian recovery.