Dealing with uncertainty. Socioeconomic forecasting during pandemic: a thankless job

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After a series of expert meetings including the Strategy for Russia academic forum, the Free Economic Society (VEO of Russia) has released a report containing VEO experts’ proposals on promoting economic recovery. The Free Economy Journal spoke with the editors of the report, Abel Aganbegyan, Alexander Shirov and Boris Porfiryev about ways to overcome the current crisis. The experts also highlighted an urgent and challenging problem that needs to be solved simultaneously with the economic recovery.

 

Boris Porfiryev,

Full member of the Russian Academy of Sciences, Doctor of Economics, Full Professor, Research Director at the Institute of Economic Forecasting, RAS

– Socioeconomic forecasting during the pandemic is not a very rewarding business, considering the strong influence of force majeure circumstances on forecast indicators. Are there any other finer aspects of such forecasting, and are there any methods for assessing their impact?

– Strictly speaking, the pandemic as such is not a hindrance to socioeconomic forecasting. If we take long-term projections, they are usually based on fairly stable trends. If we do mid-term forecasting, we need to take into account certain development risks that may be unexpected.

– What kind of risks?

– The most immediate example is something called ‘black swans.’ On the one hand, there is no way we can take these circumstances into account, but the pandemic is not a black swan. If we look carefully through the WHO annual reports, they have been warning us about something like this since 2008, urging nations, in particular, to increase their spending on healthcare.

The idea is clear – there has been a long- term trend with economic growth and urbanization exacerbating the human pressure on the environment and interference with natural ecosystems. Those factors, in turn, have been changing the human environment. The coronavirus, in this sense, is a phenomenon at the intersection of environmental and social processes.

– How exactly has the pandemic changed the socioeconomic outlook?

– First of all, it has brought great uncertainty into the picture that mainly stems from the scale of morbidity and mortality. The statistics that are published are fairly honest, on the one hand. But there is data from the response center, for example, and there is data from Rosstat. The response center records the coronavirus as a fact, but Rosstat evaluates the contribution of the coronavirus factor to the sad mortality statistics.

The problem is that if we look at survey results from around the world, the number of confirmed cases is several times, even tens of times greater than the figures in post factum reports. In Russia – even adjusted for Rosstat statistics – those numbers are 12 times higher; in India, by 200 times; in the US, by 7 times; and in Sweden, by 17 times.

As for mortality, there are discrepancies as well.

– And what does this variance mean?

– That it is very difficult to project the morbidity or mortality curves.

– Does that mean an adequate economic forecast cannot be made, taking into account such pandemic-related factors?

– There is also the vaccination factor. On the one hand, several COVID-19 vaccines have been developed lightning-fast; things have moved four times quicker than any health program we have seen before. But the actual vaccine rollout… According to available data, the needs of the – excuse my wording – least developed countries will not be fully met until 2024. India, for example, will meet its needs by 2023, and Russia, it is believed, by the end of 2021.

This adds more uncertainty to the forecast. After all, if a vaccine is available, we can reopen industrial facilities and boost economic growth. But what if it’s not? If we take GDP, the forecasts that were made at different levels of development of the pandemic vary by several percent.

– For example?

– With global GDP, the difference between various scenarios reaches 3-4%, if we take 2023 as the forecast point and look at the differences between the negative and positive scenarios. According to the IMF, they only differ by a few percentage points, but that difference is quite noticeable anyway.

– And what happens in the end?

– Trying to make forecasts during the pandemic, we need to look at the general vector of economic trends. Because we must not forget that the pandemic not only generates negative trends, but also creates demand in industries that make a positive contribution to economic growth. The financial sector in Russia has grown by 7%, for example.

There need to be forecasts, and they will be made. The pandemic can be explored by modeling and these models can be included in calculations.

– The VEO experts’ report on economic recovery says it is extremely important to improve the living standards and quality of life in Russia. What kind of standards and quality do we want to achieve, exactly?

– On the one hand, the standard of living is an objectively measurable indicator. We can use a set of parameters mainly related to disposable incomes. So it is clear that if we talk about living standards, we will probably take Europe as a benchmark. Another most important aspect is improvement in living standards. It is very important for people to feel that their standard of living is improving. For example, living standards in China are still lower than in Russia, but in recent years, people have seen a tangible increase, and this is extremely important.

– So with living standards, things are more or less clear. What about the quality of life?

– This part is more interesting. One side to the quality of life is health. The other side has to do with a set of services one can use that would meet their expectations. Those include education, recreation and entertainment. And here, subjective assessments play an exceptional role. Something that makes a US citizen satisfied, for example, can be perceived in a completely different way in Russia due to different mentality and values.

Things get even more interesting when it comes to details.

– The devil is in the detail?

– Yes, absolutely. When it comes to living standards and the quality of life, it is very important to rely on subjective assessments, on people’s satisfaction with qualitative characteristics. True, we can use health as an abstract category, use figures from the Russian Healthcare Ministry and the WHO, but quality is a subjective category. You can use those figures to tell a person the healthcare system meets the requirements, but that particular person can encounter a different situation where they are not satisfied.

As with living standards, trends also play a fundamental role here. A person should feel that the quality of their life is improving.

– So, the quality of life appears to be the most subjective concept, while the standard of living is objective, to an extent?

– At the extreme, as they say to mathematics, yes, this is actually the case. On a larger scale though, the quality of life is the most subjective aspect, but it is collectively subjective – something known as a sociological phenomenon. The standard of living is indeed an objective indicator.

But ultimately, we need to measure the standard of living to be able to assess the quality of life. The President of Russia also says that, it’s certainly good to hear your indicators are growing and your figures are positive – just make sure that people don’t complain to me. And this is the correct approach.

Alexander Shirov,

Doctor of Economics, Corresponding Member of the Russian Academy of Sciences, Director of the Institute of Economic Forecasting, RAS

– Speaking of raising people’s incomes, how quickly can the economic recovery measures proposed by VEO experts be implemented?

– The first thing you need to understand is that those proposals are not radical measures. In fact, the government worked them out last year to one degree or another, and they are already under discussion.

As for the implementation, on the one hand, they can be implemented quickly enough, but on the other, it is clear that budget processes have a certain logic that actually puts the targets beyond 2021. Yet, under certain conditions, this can be done earlier. Raising unemployment benefits and the minimum wage, including in the public sector, will cost hundreds of billions of rubles, but it is not a critical amount.

Raising pensions is a more complicated story. That will require more money, but that resource is also available. We must understand that this kind of spending does not mean the money gets thrown away, but there will be some economic effect from it.

Primarily, it will increase demand. And, as we saw last year, the additional sums get largely spent on food, pharmaceuticals and repairs, and debt repayment. I mean, people have been spending it quite rationally.

As a result, all the above will increase corporate investment. A business knows they need to invest more when there is greater demand for their products.

– Still, part of the expert community and the government believe stimulating demand by handing out money will accelerate inflation. Is this not true?

– If we look into the logic of those who voice such concerns, there is this term – the output gap. It implies the level of output consistent with no pressure for prices to rise or fall.

It means the increase in production is not accompanied by excess demand and does not lead to full production capacity utilization. Prices begin to rise when there is no capacity to produce more. But Russia has more than enough vacant capacities because demand has shrunk in all sectors. Last year, by the way, government spending increased by 26.6% compared to 2019. This is a colossal growth. But has the financial stability been disrupted? No. The entire price drama, which was also discussed with the President, is not linked to our internal problems. It is fueled by what happened in foreign markets, plus domestic exchange rate formation. About 80% of the pressure on prices comes from the outside.

At the same time, our reserves are the same as they were, and inflation is within acceptable limits.

– Speaking of reserves, we should admit that the Ministry of Finance is rather unwilling to spend money, and instead chooses to accumulate it in funds such as the Russian National Wealth Fund. Along with political will, what else is required for opening the ‘money box’ at last?

– A certain shift in attitude has already taken place in this regard. Last year, the budget deficit was financed primarily through domestic borrowings from domestic banks. This was a reasonable effort as it provided an opportunity to maintain the said reserves and develop the domestic financial market (the more bonds we issue the larger the market, which is good).

On the other hand – and here we are speaking about the doctrine – such financing of the current deficit means that we have reached a point where we split expenditure into the current budget financed from current expenses and borrowings, and the development budget financed from the Fund. The discussion is now centered on where exactly finances from the fund will go.

It definitely seems reasonable to finance expenditure that would boost economic potential in the mid-term – that is, major investment projects. Part of the finances could go for paying back our social debts; yet I think that large-scale projects will be a priority, and this is right as the fund’s revenues are non- recurring; they depend on the current situation in the global markets and should be spent on non-recurring expenditure, correspondingly.

– What is the maximum required amount? Can we say now that it will bring more returns for the economy?

– The accumulation rate, which is investment’s relationship to the GDP, has remained at 21% for a long while. In order to achieve a fairly sustainable growth, we should have it at least at 24-25%. Given that our GDP is about RUR 100 trillion, the growth of 3-4% is what we should achieve as regards investments.

Yet, we understand that our investments are made mostly through state resources, which is about 20%. So if it is 20% of
3-4 trillion, you can estimate the amount to be provided by the government, while businesses will invest the rest. These are not large amounts, just about RUR 1 trillion per year and even less.

– When are these finances expected to bring dividends?

– Our average investment cycle today is about three years. When the government is involved, with large-scale projects underway, it obviously extends to 3-5 years. Yet, investments produce income when they work as there is a demand for machinery, equipment, and construction activities.

– How much return will an invested amount of RUR 1 trillion bring over such period of time?

– For instance, we have state investments that go for infrastructure development, with every invested ruble bringing in two rubles in return. Plus, every invested ruble results in business investments in the ratio of 1 to 4 or even 1 to 7. These additional 3-4 rubles produce another two rubles each. This is a substantial investment multiplier that can be compared to a big and complicated car which is slow to accelerate – but once it starts it will not stop. The issue is how we can launch this investment cycle.

– Along with the government, who else should launch it?

– There is no one else to do it, and that is the point. The government’s efforts to invest in projects, which generate demand from business, should go together with an impetus from the economy. Businesses have to see that the economic sector has demand for their products.

Abel Aganbegyan,

Full member of the Russian Academy of Sciences, Doctor of Economics, Professor

– A reform of ownership and financial system, a tax reform, a reform of regional management, and a return to five-year economic plans – which are the easiest initiatives to be promptly launched?

– First of all, I would not risk implementing any reforms during the crisis. Raising pensions, unemployment benefits and wages – these are not reforms but the efforts to restore the long-lost living standards we had back in 2012. Since then, real disposable household incomes have plummeted almost 15% by 2021.

Efforts to increase wages and benefits are not sufficient to raise the said incomes by 15%. This requires nation-wide measures such as debt reorganization; today, up to 30% of wages is spent for loan repayments, with the banking sector making the most profit during the crisis.

– It appears that all these reforms should be launched only after consumer purchasing power is restored?

– This is not only about its recovery; reforms should be started when a significant annual economic growth of at least 3-4% takes place. Such rate was last observed in 2010-2012.

– How it can be achieved?

– First, what does economic advancement depend on? There are several drivers, the main one being fixed-asset investments. If you want to advance, you have to launch expansive technological refitting of core industries, primarily engineering. In 2019, total investments of the kind amounted to RUR 18 trillion.

The second driver is knowledge economy growth. Switching to new technologies requires personnel able to handle these technologies and manage them. Such personnel has to be trained by developing the quality of human capital asset through knowledge economy, research and advanced development, education economics, and information and communication technology. As regards investments in knowledge economy, the required amount is estimated at RUR 14-15 trillion within the next three years. We must spur growth in these two areas.

– How many years will Russia’s economy take to return to such growth rates?

– About 2-3 years, I think.

– You have mentioned several such drivers for growth…

– The third driver is housing construction, a sector that boasts the largest multiplier effect. Completing more residential housing construction requires more utilities to be connected, with more money put into infrastructure and transport. People purchase apartments and start paying bill based on water and electricity meter reads. Efforts to boost the housing construction activities will lead to a considerable growth of the entire sector. Launching 10% more residential housing will allow for an annual GDP growth of 2%. This is easy to implement.

– Why no-one is taking efforts in this regard?

– This is because we choose to accumulate money instead of spending it. Between 2017 and August 2020, we spent some RUR 15 trillion to purchase foreign currencies and gold – while the amount required for an annual growth of 10-15% in investments and knowledge economy is estimated at RUR 5 trillion. This means we could have put finances in these areas during three years and we could have achieved a 3% GDP growth in 2019.

We are literally sitting on trunks full of gold. In August 2020, Russia’s gold and foreign currency reserves for the first time exceeded $600 billion. Today we have more reserves that the US does and more than Germany, France, Great Britain and Italy have altogether. And this is the amount that we will need under no circumstances.

– And how much will we need?

– In the past 30 years, the largest amount we spent for minimizing economic issues was $211 billion out of $597 billion in 2008-2009; this was the period when we saw our GDP shrinking by 8% and the industry plummeting by 11%, while now the GDP and the industrial sector have indicated a 3% fall each. The unemployment rate was higher during that period as well. So what is the point of keeping such amounts of money instead of spending it? During the crisis of 2020, Russia had a budget surplus – an unprecedented occurrence when a country has money left in its budget in an ominous economic situation. Just imagine going without food while having RUR 100,000 at home. So what is the point?

– A report that features proposals by experts of the Free Economic Society of Russia on restoring the economy says that “the most complicated yet most important task is to preserve the Russian nation.” What do you mean by that?

– The term ‘preservation of the nation’ was first introduced by Mikhail Lomonosov in his well-known note to Ivan Shuvalov, founder of Moscow University, arch-chamberlain and Active Privy Councillor.

Preserving the Russian nation is the goal of the government as well as the goal of the country’s social and economic development.

Obviously, the nation’s integrity directly depends on its living standards.

A natural sustainable population growth is what preserving the nation means. This is what we have yet to achieve, with the excess mortality totaling 358,000 between April and December 31, 2020, indicating an 18% growth.

Along with natural population growth, this also includes life expectancy. The rise in mortality has led to a lower life expectancy, from 73.4 years in 2019 down to 71.4 in 2020.

And this is the biggest loss. This is more essential than the GDP or the industry as it affects a vast number of families. These 360,000 deaths included some 60-65% men of employment age who were family breadwinners.

– What are the further trends?

– In the first quarter of 2021, we expect the death rate to increase to 400,000 people, and possibly to reach 500,000 mid-year. Unfortunately, I do not yet see any program aimed at reducing mortality; there is no plan available. Media reports say that the government is working to achieve national goals – and I hope these documents include a section that seeks solution to this key problem.

– And this requires additional resources…

– Indeed, the anti-crisis program and budget for 2021-2023 imply very small figures. A small amount has been allocated for the anti-crisis program; for instance, expenditure on education is diminishing, as well as on many other budget items.

I am confident that the government will provide additional finances as it was drawing up the anti-crisis program and the budget when we were at the beginning of the second wave of Covid-19 pandemic, and we never thought in a million years that we would see it last twice as long and lead to figures increasing threefold as compared to the first wave.

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