Growth and Labor Sufficiency in Russia: Will Russia Face Labor ...

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Will Russia Face Labor Force Shortage in the Next 20 Years? Background ... Sources of GDP growth over 2000-2010 in Russia and its two federal districts .
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Growth and Labor Sufficiency in Russia: Will Russia Face Labor Force Shortage in the Next 20 Years? Background Note1 Draft, July 2011

The World Bank

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This background note prepared by Toru Nishiuchi and Yulia Mironova (ECSPE Consultants) under the guidance of Sudharshan Canagarajah (ECSPE Lead Economist). We are grateful to Sergey Ulatov, Karlis Smiths, Victor Sulla, Shoghik Hovhannisyan and Matin Kholmatov for helpful comments and suggestions. Authors’ e-mail address: [email protected], [email protected]

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DRAFT, NOT FOR DISTRIBUTION Table of Contents Introduction ........................................................................................................................................................ 3 1.

An analytical framework .............................................................................................................................. 4

2.

Labor force projections under various demographic scenarios ................................................................... 6

3.

Sources of GDP growth over 2000-2010 in Russia and its two federal districts ........................................... 9

4.

Estimation of potential labor force deficit/surplus in the next 20 years .................................................... 12

5.

Concluding observations and policy implications ...................................................................................... 14

References ........................................................................................................................................................ 16 Annex I: Data Sources........................................................................................................................................ 17 Annex II: Simulated labor deficit/surplus in Russia: Optimistic scenario ............................................................ 18 Annex III: Simulated labor deficit/surplus in Russia : Pessimistic scenario.......................................................... 19 Annex IV: Simulated labor deficit/surplus depending on TFP growth rates in Central and North -West Federal Districts ............................................................................................................................................................. 20

Figures and Tables Figure 1: Labor and Capital Income in 1995-2010 (percent of GDP) .................................................................. 5 Figure 2: Demographic forecasts, total and working age (15 -64 years old) population, million people .............. 6 Figure 3: Labor force participation projections up to 2030 under various demographic scenarios ..................... 8 Figure 4: Estimated factors contribution to total and non-oil-gas GDP growth in Russian Federation, 2001-2010 (percentage points) ............................................................................................................................................. 9 Figure 5: Estimated factors contribution to GRP growth in two federal districts of Russian Federation, 20012009 (percentage points) .................................................................................................................................. 11 Figure 6: Simulated labor deficit/surplus depending on TFP growth rates for Russian Federation, by 2020 and 2030 .................................................................................................................................................................. 12 Figure 7: South Korea total factor productivity growth rates, 1985 -2008 (percent per year) ........................... 14 Figure 8: Average TFP growth in selected OECD countries, 1985-2008 (percent per year) ............................... 14

Table 1: Results of Growth Accounting for total and non-oil-gas GDP for Russia, 2001-2010 based on actual data, 2011-2030 based on forecasted values (percentage points) .................................................................... 10 Table 2: Simulated labor deficit/surplus depending on TFP growth rates for Russian Federation and its two federal districts, by 2020 and 2030 ................................................................................................................... 13

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Introduction

R

ussian economy demonstrated strong economic performance over the decade prior to the global economic crisis in 2008 and 2009. Economic growth averaged 6.9 percent per year and GDP per capita increased almost nine times in nominal US dollars terms over the period from 1999 to 2008. This growth episode began as a bounce-back after the 1998 financial collapse. With a weakened ruble, domestic manufacturers were better positioned to compete with imports. Then, as oil prices climbed, the country saw a large inflow of foreign exchange, further fueling growth and centering the Russian economic growth model on high prices of hydrocarbons, which generated about 20 percent of total GDP, half of the budget revenues and accounted for about 60 percent of Russian merchandise exports. Strong economic growth in Russia created vast economic opportunities for neighboring countries which benefited from exports expansion at the Russian market, incomes generated by labor migrants attracted to Russia by substantial wage differentials, and Russian investments. Total Russian imports from CIS countries more than tripled between 2001 and 2008. Exports of labor to Russia from the poorest CIS countries – Tajikistan, Kyrgyzstan and Moldova - appeared to be even more critical for their welfare than the trade-in-goods linkage. Remittances from labor migrants working in Russia constituted a very significant source of incomes for population in those countries, accounting for 30 -50 percent of their GDP in 2008. Estimated total number of foreign labor migrants working in Russia was about 2.5 million people, or 3.4 percent of total employment; at that labor migrants accounted for over 10 percent of total employment in Moscow city 2, major center of economic activities in Russia, where jobs for migrants were mainly created in non-tradable sectors, including construction, retail trade, and selected types of services. Following a decade of strong economic growth, the country was hit hard by the crisis. Even though the authorities saved significant portion of the oil revenues in the Russian Stabilization Fund, they gradually began to spend more and more of it in the years preceding the crisis. At the same time, private sector activity was also very dynamic. So when the crisis hit and oil prices collapsed, the economy was overheated, and therefore output declined by more than in other countries (IMF, 2010). The government implemented massive fiscal stimulus of about 10 percent of GDP to protect the economy. Despite large stimulus and favorable commodity prices, growth has been modest - 4.0 percent in 2010 and 4.1 percent in Q1-2011. Ministry of Economic Development of Russian Federation forecast average real GDP growth of 4.1 percent per year over 2011-2014, which is broadly in line with the WB, IMF and EIU outlook for Russia. The crisis demonstrated again external vulnerability of the Russian economy. Economic team of the Russian Government recognized that new drivers of growth are needed for Russia to sustain steady economic growth in future. Economic modernization to boost productivity and export diversification is among the top priorities on the Russian economic policy agenda. However, this task is complicated by demographic situation in Russia, which po pulation has been declining over the last decade and which implies declining working age population in the next decade or two. This means that in order to achieve targeted economic growth rates the country may need to attain even higher productivity gains. 2

http://mirpal.org/Статистика/Сводные%20таблицы%20за%202005-2008%20гг..html

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DRAFT, NOT FOR DISTRIBUTION This note therefore attempts to quantify relationship between economic growth and growth of labor force, using growth accounting relationship, in order to clarify the gap between projected number of labor force of Russian nationals under various demographic scenarios and required number of labor force to achieve targeted level of GDP under various assumptions on total factor productivity (TFP) growth, population’s participation rates in labor force and capital accumulation level. The note is organized as follows. Section 1 presents an analytical framework. Section 2 provide s projections of labor force under several demographic scenarios. Section 3 analyses sources of growth in Russia and in two Russian Federal Districts during 2000-2010, differentiating between total GDP growth and non-oil-gas GDP growth. This analysis underlines assumptions in scenarios used in simulations to estimate labor force deficit/surplus in Russia in the next twenty years presented in Section 4. Policy implications and concluding remarks follow.

1. An analytical framework

W

e use a standard growth accounting framework to analyse sources of growth in Russia, differentiating between growth generated by labor and capital inputs contribution and contribution from the increases in total factor productivity (TFP). We consider a model of an open economy that evolves in discrete time and each time period, denoted by an index, represents one year (World Bank, 2011). We assume that the economy has access to a technology to produce output by combining capital and labor inputs according to the Cobb-Douglas production function with constant returns to scale defined by equation (1): (1) where denotes output, is the stock of physical capital, denotes the amount of labor input, is a measure of the productivity level of capital and labor, and the technology parameter  which measures the relative contribution of capital to the production of output and which in a competitive economy coincides with the share of output distributed as payments to capital. Capital depreciates at a constant rate of  between time periods and can be augmented through investment evolving according to the equation (2): (2) where denotes aggregate investment. We assume that capital depreciation rate is 0.05, which is commonly used in the literature. Imposing various assumptions on targeted GDP growth, TFP growth, and investment-to-GDP ratio we simulate required labor force growth rate under various scenarios using the equation (3):

(3)

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DRAFT, NOT FOR DISTRIBUTION Finally, we estimate potential labor force deficit/surplus as a difference between projected labor force under various demographic scenarios and required labor force estimated using growth rates obtained by equation (3). We understand various limitations of this framework as well as of the data. Growth accounting methodology has been criticized, among others, for “residual” nature of the TFP growth, for the underlying assumptions about production function and for that it cannot identify whether the productivity growth caused the capital accumulation, or whether the capital accumulation made additional innovations possible. The other concerns refer to measures of changes in output and the inputs and to choice of parameters, including possible underutilization of available capital stock or employed labor, and sensitivity of the results to the choice of the technology parameter α which as empirical evidence demonstrate varies substantially across the countries (Gollin, 2002). However, there are studies (Bosworth and Collins, 2003 and Caselli, 2004), which we rely on, arguing that growth accounting is a valuable tool that can - and have - improved understanding of growth experiences across countries. We address some of the limitations. First we use data on capital stock adjusted for capital utilization (see World Bank, 2007a and IMF, 2006). Second, we use observable estimate for parameter measured as share of profits and mixed incomes in total value added (see Figure 1 a). Third, though this simple growth accounting framework as it currently stands does not include other growth determinants – such as the savings rate - we incorporate sensitivity analysis of labor requirement various combinations of investment rate which is highly correlated with savings rate (see Figure 1b). Figure 1a: Labor and Capital Income in 1995-2010 (percent of GDP)

Source: NSC RF

Figure 2b: National savings and investment rate, average 1980-2008

Source: Savings and Growth in Egypt, World Bank (2011)

Finally, with all limitation, we believe that this framework is still useful to demonstrate how labor force needs in Russian Federation may change in future depending on targeted economic growth rates, improvements in factors productivity, level of participation of working age population in labor force and investment levels; so the Government could address potential labor force shortage beforehand. The analysis presented in this note is conducted in three steps. First, we project labor force in the next twenty years for the three demographic scenarios provided by the National Statistics Committee of Russian Federation (NSC RF) and imposing several alternative assumptions on expected labor participation 5

DRAFT, NOT FOR DISTRIBUTION rate (LPR). Second, we use presented above framework to estimate TFP contribution to GDP growth in Russia over the last decade, differentiating between oil-gas and non-oil-gas GDP. We also analyse sources of growth using this framework for two Russia’s regions. Third, we estimate the gap between projected number of labor force of Russian nationals and required number of labor force to achieve targeted level of GDP under various assumptions on TFP growth, LPR and investment-to-GDP ratio.

2. Labor force projections under various demographic scenarios

R

ussian Federation has been undergoing though the period of sharp demographic decline over the last decade. Despite strong and robust economic growth, Russia over these years has been facing exceptional population decline fueled by low fertility and high mortality in large part due to untimely deaths from heart disease and traffic accidents. Between 1992 and 2009 Russia’s population declined by approximately 7 million from 149 in 1992 to an estimated 142 million people, which is corresponding to Russia’s population in 1984. Migration has become the only source of population growth. According to UNFPA (2010) total natural population decline for these years amounted to 12.6 million, which implies that migration compensated for approximately half of it. Recent years recorded however assuring population increase up to estimated 142.9 million in 2010. The natural decline of Russia's population in 2009 went down by almost a third; birth r ate grew by 2.9 and death rate reduced by 3 percentage points. Improved health outcomes also contributed, so that child mortality in Russia decreased by 3.5 percent, cardiovascular diseases' toll went down by 4.6 percent, and the TB death rate declined 7.8 percent in 2010. Unfortunately reduction of population decline rate in recent years is likely to be only a temporary trend for a number of reasons. First, a significant increase in the number of women of childbearing age as a result improved fertility in the 80s, contributed to an increase in the numb er of births. Second, starting from 2001 the 60-year mark was passes by a smaller generation born during the war, which inhibited the growth of the number of deaths. The influence of both factors will weaken in the next few years, i.e. the number of potential mothers will return to the level of the early 90s, and the number of elderly will start growing at expense of the most Figure 3: Demographic forecasts, total and working age (15-64 years numerous post-war generations. old) population, million people As a result favorable impact of these structural factors on the population growth in the first decade of XXI century, in its second decade will reverse (see UNFPA, 2010 for details). Almost all the forecasts predict a further reduction Russia's population, although at different rate of reduction. This will lead to a decline of working age population. Figure 2 illustrates Source: NSC RF potential decline of working age 6

DRAFT, NOT FOR DISTRIBUTION population for three demographic scenarios based on the forecast prepared by N SC RF. This shows that number if working age population may decline from about 103 million people as of 2010 up to 86.4 million in 2030. The direct economic consequence of this decline is a reduction of productive labor force which may potentially have negative implication for economic growth. In this section we present estimated labor force participation (measured as number of employed) in the next twenty years for the three demographic scenarios and imposing several alternative assumptions on expected labor participation rates as in the situation of declining population increasing labor participation rates could partially solve the problem of shrinking labor force. We use population projections by age group and sex provided by NSC RF. In projecting the number of labor force, we rely on three demographic scenarios - baseline, optimistic and pessimistic (see Figure 2) and impose following assumptions on labor force participation rates: (a)

Base case: participation rates by age and gender will remain at average level observed over 2006-2008; we exclude 2009 as there was increase in unemployment in 2009 due to the crisis

(b)

EU25 convergence: participation rates for all age-gender groups will move toward those of the current average of the 25 members of the European Union, converging by 2030; currently EU25 LPRs are substantially higher than in Russia for younger and older people (15-24 years old and over 60 years old)

(c)

2.5 percent across the board: gradual increase in labor force participation rates for all age gender groups, reaching a level 2.5 percentage points higher than they were in 2006-2008

(d)

Older workers: gradually increasing participation rates for workers, age 60 to 64, so that the rates are 5 percentage points higher in 2030 than in 2006-2008

(e)

40 to 59 year olds: gradually increased participation rates for both men and women in this age group, so that the rates are 5 percentage points higher in 2030 than in 2006-2008

Labor force participation projections for the three scenarios are presented in Figure 3. In 2006-2008 total employment averaged at 70.2 million people. Our estimate for labor force participation by the year 2030 varies from 62.9 to 69.1 million for the baseline demographic scenario, from 65.3 to 71.8 million for the optimistic demographic scenario, and from 60.1 to 65.7 million under pessimistic scenario. This means that if pessimistic demographic scenario realizes and labor participation rates will remain unchanged at the level of 2006-2008, labor force participation may decline by as much as 10 million people or by 14.3 percent from the current level. This will be a fairly substantial burden on economic growth as it will be more difficult to sustain high growth rates. Figure 3 shows that beyond promoting across the board increase in labor participation rates decline in labor force is mitigated by policies encouraging higher participation of younger people (15-24 years old) in the labor force and promoting middle-age workers (40-59 years old and older) to stay longer in labor market. The later could be practically implemented through postponing retirement age, but given the low levels of life expectancy in Russia, this seems to be politically difficult to implement. In addition to declining labor force in Russia, its quality is deteriorating in terms of education. 2011 Global Competitiveness Report for Russia (WEF, 2011) argues that although the country’s highly educated population is now among its key advantages; Russia will most likely not be able to maintain this advantage 7

DRAFT, NOT FOR DISTRIBUTION Figure 4: Labor force participation projections up to 2030 under various demographic scenar ios

Source: own calculations based on data from NSC RF 8

DRAFT, NOT FOR DISTRIBUTION over the medium to longer term without major investment into improving the quality of educational system. The past five years have seen a significant deterioration in the quality of education in Russia, even in math and science - which had been one of the key strengths of the Russian education while educational outcomes in India, China, and Brazil have been improving and OECD countries show stable results. Though in our further analysis we do not account for the deteriorating quality of labor force, as measured by its education, we believe that this argument makes our findings stronger.

3. Sources of GDP growth over 2000-2010 in Russia and its two federal districts

A

nalysis of sources of growth obviously is not the main focus of the exercise presented in this note as it can add little value to the existing rich literature studying the drivers of growth in Russia. We decompose sources of growth in Russia here primarily to see what happened in very recent years and whether they (sources) were different for non-oil-gas and overall economy. The later is important as contribution of oil and gas sectors in overall growth is expected to be zero or negative in the next decade, which is already captured in the medium-term economic forecast for Russian Federation for 2011-20143. This implies that economic growth will have to be generated in non-oil-gas sectors, and those potentially could require higher labor inputs. Overall GDP growth in Russia during the period from 2001 to 2008 was mainly driven by increased productivity, whereas the accumulation of labor and capital played a minor role. World Bank flagship report on productivity in Europe and Central Asia (ECA) explains that large part of the productivity gains in Russia were derived from increased capacity utilization, particularly in manufacturing. As firms began using their excess labor and capital, which had become idle during the deep transitional recession, output increased, and this is captured in TFP estimates (see Figure 2). Figure 5: Estimated factors contribution to total and non-oil-gas GDP growth in Russian Federation, 2001-2010 (percentage points)

Source: own calculations based on data from NSC RF, WB WDI database, and dataset from World Bank (2008) During the first half of the past decade TFP contribution to growth in non-oil-gas sectors was slightly lower than for total economy. This implies that productivity gains were higher in oil and gas sectors. Few years 3

http://www.economy.gov.ru/minec/activity/sections/macro/prognoz/doc20110422_010

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DRAFT, NOT FOR DISTRIBUTION before the crisis, during 2006-2008, TFP contribution in non-oil-gas sectors was higher than for total economy. Recent Global Competitiveness Report for Russia (WEF 2011 ) also shows that recently productivity in supporting sectors (which are mostly market services, including construction, retail trade, hospitality and etc.) grew faster than in many basic sectors (mining and manufacturing, where the government is the main proponent and owner). However, dynamic development of supporting sectors was fueled by oil incomes, which cannot drive the future growth. Results of the growth accounting illustrate that even moderate rates of economic growth in the next two decades will require sustaining high TFP growth rates between 2.5 and 4.1 percent per year, particularly in non-oil-gas sectors. Table 1 shows estimated average contribution of TFP to growth (total and non-oil-gas) over 2001-2010 and required TFP gains in order to generate targeted economic growth in the next two decades under the following assumptions: (a) Economy will grow at average rate of 4.5 percent per year. This rate corresponds to recently announced medium term targets of the Russian government and also equal to the weighted average annual growth rate of the top four developing recourse-rich countries (Brazil, Chile, China and South Africa) during 2000-2009; (b) Oil and gas sector contribution to overall growth will be on average negative 0.5 percent per year for 2011-2020 and zero percent for 2021-2030; (c) Capital stock will grow at the rate generated by investment-to-GDP ratio equal to 2005-2010 average of 24.1 percent of GDP; (d) Labor force growth rate as defined by three scenarios selected from those presented and discussed in the section 2. In the most optimistic case from the three labor force scenarios considered (Table 1) achievement of the targeted economic growth rate of 4.5 percent per year in the next two decided will require TFP growth of about 3 percent per year on average, with slightly higher requirement in the non-oil-gas sectors. Table 1: Results of Growth Accounting for total and non-oil-gas GDP for Russia, 2001-2010 based on actual data, 2011-2030 based on forecasted values (percentage points) Actual 20012005

2006-2010

Scenario 1: Base case LPR est. for baseline population forecast 2011-2020

2021-2030

Scenario 2: 2.5 % increase LPR est. for optimistic population forecast 2011-2020

2021-2030

Scenario 3: Base case LPR est. for pessimistic population forecast 2011-2021

Total GDP Output 6.4 2.3 4.5 4.5 4.5 4.5 4.5 Capital 0.7 1.5 1.6 2.0 1.6 2.0 1.6 Labor 0.8 0.4 -0.4 -0.3 -0.2 0.0 -0.5 TFP 5.0 0.4 3.3 2.8 3.1 2.5 3.4 Non-oil-gas GDP Output 5.2 2.1 5.0 4.5 5.0 4.5 5.0 Capital 0.4 1.2 1.4 1.9 1.4 1.9 1.4 Labor 0.8 0.3 -0.4 -0.3 -0.2 0.0 -0.5 TFP 4.1 0.6 4.0 2.8 3.8 2.5 4.1 Source: own calculations based on data from NSC RF, WB WDI database, and dataset from World Bank (2008)

2021-2030

4.5 2.0 -1.0 3.5 4.5 1.9 -0.4 3.0

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We also repeat growth accounting exercise to see if sources of growth differ between the regions currently facing labor shortage and regions with adequate labor supply. We use lower share of foreign labor migrants in overall employment as a proxy for labor sufficiency . We chose Central Federal District (as the largest recipient of labor migrants, which could indicate existing shortage of domestic labor) and North-West Federal District (as region with lower share of labor migrant in total employment). Both regions account for the bulk of economic activity in the co untry and both feature post-industrial economic structure. We use data on Gross Regional Product (GRP) growth and employment available in the official statistics and capital stock is estimated applying actual shares of respective regions in total capital stock at remaining balance sheet value also available in the official statistics. Figure 6: Estimated factors contribution to GRP growth in two federal districts of Russian Federation, 20012009 (percentage points)

2001-2005

2006-2009

Output Capital Labor

8.4 2.0 0.6

1.5 4.3 0.1

TFP

5.8

-2.9

Output Capital Labor TFP

2001-2005

2006-2009

7.7 0.9 0.8 6.1

2.7 0.5 0.0 2.3

Source: own calculations based on data from NSC RF, WB WDI database, and dataset from World Ban k (2008) Results of the growth accounting at regional level are presented at Figure 5: 



Pattern of TFP contribution to GRP growth in North-Western federal district is broadly the same as at the country level, i.e. GRP growth between 2000 and 2008 was mainly driven by increased productivity, whereas the accumulation of labor and capital played a secondary role. Sources of growth in the Central Federal District reveal somewhat different picture. GRP growth, particularly in 2007 and 2008, was driven by capital accumulation and productivity gains during these years were marginal. Given that this region accommodates large number of foreign migrants, this may indicate that low skilled labor (as majority of labor migrants are low -skilled employed in supporting sectors) impedes productivity growth. From the other point of view it may signal that low productivity is compensated by cheap low-skilled labor. But it is also likely that the capital stock in this region is overestimated due to large share of non-productive investments (housing and commercial real estate). Therefore, it is not appropriate to conclude that this region has different patterns of 11

DRAFT, NOT FOR DISTRIBUTION productivity growth, but given its significance for economy, it may well deserve more in -depth analysis of growth drivers.

4. Estimation of potential labor force deficit/surplus in the next 20 years

I

n this section we present results of the estimation of the gap between projected number of labor force of Russian nationals (as described in Section 2) and simulated required number of labor force to achieve targeted level of GDP under various assumptions on TFP growth, LPR and investment-to-GDP ratio for the optimistic and pessimistic scenarios defined as follows: Optimistic scenario:

Pessimistic scenario:

- 6 percent average annual GDP growth, - 2.5 percent increase in labor participation rate based on optimistic population forecast, - average investment ratio 25 percent of GDP - TFP annual growth varies from 0.5 to 5.0 percent

-

3.0 percent average annual GDP growth, baseline labor participation rate, average investment ratio 15 percent of GDP TFP average annual growth varies from 0.5 to 5.0 percent

We conduct growth accounting exercise at national level for non-oil-gas GDP by adjusting GDP growth rates, labor force and investments on estimated contribution of oil and gas sectors, assuming that:   

Oil and gas sector contribution to overall growth will be on average negative 0.5 percent per year for 2011-2020 and zero percent for 2021-2030, Share of employed in these sectors will remain at average level of 2005-2009 (1.8 percent of total) , Share of oil-gas investments will remain at average level of 2005-2009 (20 percent of total) during 2011-2020 and will slightly decline during 2021-2030 (up to 15 percent of total).

Figure 7: Simulated labor deficit/surplus depending on TFP growth rates for Russian Federation, by 2020 and 2030 Russia: Optimistic Scenario 4

0

-2

-30,000

-4

-60,000

-6

-90,000

-8

-120,000

-180,000

20,000

3

0

0

2

0

-150,000

6

TFP, annual growth rate

-10 Labor f orce def icit "-"/surplus "+" by 2020 Labor f orce def icit "-"/surplus "+" by 2030

-40,000

Labor, required annual growth rate

-80,000 -100,000

-6 -9

-60,000

-12 -14

-3

-20,000

%

thousand people

30,000

40,000

6

thousand people

60,000

Labor, required annual growth rate

Russia: Pessimistic Scenario TFP, annual growth rate

%

90,000

Labor f orce def icit "-"/surplus "+" by 2020 Labor f orce def icit "-"/surplus "+" by 2030

Source: own calculations based on data from NSC RF, WB WDI database, and dataset from World Bank (2008)

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-12 -15

DRAFT, NOT FOR DISTRIBUTION We do not do oil-gas adjustment at regional level as none of these two regions is major oil or gas producer. By solving the growth accounting equation for growth rate in labor force (see equation (3) in section 1), we obtain required growth rate in labor force using hypothetical range for TFP growth rate from 0.5 to 5.0 percent. The results of the simulations at national level are presented in Figure 6. Table 2 summarizes results of the simulations at national and regional level; detailed simulations results at national level are presented in Annex II and Annex III, simulations results regional level are included in Annex IV. Table 2: Simulated labor deficit/surplus depending on TFP growth rates for Russian Federation and its two federal districts, by 2020 and 2030

Population, 2009, mln. ppl Employment, 2009, mln. ppl Share of labor migrants in total employment, 2008, % Optimistic case Est. hypothetical labor force deficit "-"/surplus "+" under conservative long-term TFP growth of 0.5 percent per year by 2020, mln. ppl by 2030, mln. ppl TFP growth at which domestic labor supply will be about sufficient, % Pessimistic case Est. hypothetical labor force deficit "-"/surplus "+" under conservative long-term TFP growth of 0.5 percent per year by 2020, mln. ppl by 2030, mln. ppl TFP growth at which domestic labor supply will be sufficient, %

Central Federal District 37.1 19.1 5.4

North-West Federal District 13.4 7.2 2.8

Russian Federation 141.9 68.1 3.4

-16.6 -45.7

-5.8 -15.5

-63.3 -178.1

4.4

4.1

4.5

-9.6 -22.2 3.0

-5.3 -13.6 4.0

-36.5 -86.2 3.2

Source: own calculations based on data from NSC RF, WB WDI database, and dataset from World Bank (2008) The main findings of the analysis are the following: 

Domestic supply of labor in Russian Federation could be sufficient to ensure long-term non-oil-gas growth rate of above 3.0 percent with moderate level of investments in non-oil-gas sectors (of 15% of GDP) if the country is able to sustain strong productivity growth rates of above 3.2 percent per year in a long-term.



Above 6.0 percent long-term non-oil-gas growth rate combined with investment rate of 25% of GDP in non-oil-gas sectors will require stronger TFP growth of about 4.5 percent per year in long term, which could be feasible for the country like Russia – example of Korea over the period of 1985-2008, when annual TFP growth averaged at about 4 percent (Figure 7), demonstrates that this is feasible.



Yet, one should note that Korea’s experience is exceptional. Average TFP growth rate in the last two decades in the most of OECD countries have been modest (See Figure 8). The large difference in productivity levels between Russia and the advanced economies may phase out as rapid productivity gains acquired through the catch-up effect, which took place in Russia, does not last long. As labor and capital efficiency increases, room for capacity utilization and labor adjustment decreases, resulting in decline in TFP growth. Historically, no country has sustained high level of TFP growth in the long run (see Englander and Mittelstadt, 1988). 13

DRAFT, NOT FOR DISTRIBUTION Figure 8: South Korea total factor productivity growth rates, 1985-2008 (percent per year)

Figure 9: Average TFP growth in selected OECD countries, 1985-2008 (percent per year)

Source: OECD 

The lower TFP growth rates or higher economic growth targets in a long-term could require larger capital investments or higher growth rates of labor force. The later will likely lead to a shortage of labor (see Table 2 and Annexes II-IV for details), which can be addressed through various policy interventions, including among others measures aimed at increasing LPRs, improving health/education outcomes, or attracting labor migrants from abroad.



The exercise yields results which are consistent at country and regional levels.

5.

Concluding observations and policy implications

T

he findings of the simple growth accounting exercise presented in this note demonstrate that given difficult current demographic situation in Russia, the country may face labor shortage in the next 20 years. We found that if pessimistic population forecast realizes labor force participation by the year 2030 may decline by as much as 10 million people or by 14.3 percent from the current le vel. This will be a fairly substantial burden on economic growth as it will be more difficult to sustain high economic growth rates. Russian government fully recognizes importance of demographic problems and implements combination of policies aimed at improving demographic situation, including complex measures to improve health (longer life expectancy, higher birth rates, lower level of diseases, etc.) and education outcomes under the national programs “Health” and “Education” and to provide better living conditions under the national program “Affordable and Comfortable Housing”. However these measures will not likely yield quick results, i.e. improve demographic satiation, in the next 10 -20 years. Russian policy makers have various instruments available to address the decline in the population of working age in sort- and medium-term. Increasing labor participation rates, postponing retirement ages, stimulating the labor market participation of women and migration policies are among those instruments. Increased immigration has the advantage of having an immediate effect on the age and composition of the population because of the younger age structure of net migration. In addition, fertility rates of immigrant women are often relatively high, which can boost fertility and hence long-term population growth. The role of migration policies, however, in addressing demographic challenges can only be complementary to other policies and is subject to a number of practical and political constraints. 14

DRAFT, NOT FOR DISTRIBUTION Russia has been already receiving large inflows of labor migrants which partially offset decline in total population (see paragraph 1 in section 2). But these massive migrant inflows featured mostly un-skilled labor which was attracted by large wage differentials fueled by country’s oil wealth. With envisaged decline of oil and gas sectors output, the needs in this type of labor will subside. Now the Government may consider setting up new requirements for recruitment of foreign labor (e.g. education, skills, age groups, etc.) to be able to attract labor of higher quality to specific sectors or regions. This will not only help to close the labor market gap, but contribute to overall labor productivity and country competitiveness improvement. This will, however, require substantial preparatory work, including labor needs assessment at sectoral and regional level. We show that domestic supply of labor in Russian Federation under current demographic trends and maintaining current level of investments could be sufficient to ensure sustainable long-term non-oil-gas growth rate of above 3.0 percent only if the country is able to sustain strong productivity growth rates of about 3-4 percent per year in a long-term. These are high rates, but feasible. First, there are examples demonstrating that this is possible - South Korea sustained 3.9 percent average total factor productivity growth rates over the period from 1985 to 2008. Second, strong productivity gains in Russia over the last decade were derived at large extent from increased capacity utilization. Macroeconomic stability, better governance and business environment, financial deepening, and investments in infrastructure, particularly in information and communication technology (ICT), were other drivers of productivity growth (see WEF, 2011). However, it is commonly agreed that Russian economy still has substantial potential to improve its productivity. The Russian government is inclined to realize this potential using traditional industrial policy instruments. A number of analytical/policy studies, however, warn that productivity growth may require more fundamental structural reforms. For example, WB RER (2011) discusses factors with the strongest positive impact on productivity of Russian firms, which include investment climate, competition policy, innovations and skills level of labor. WEF GCR (2011) suggests that Russia can realize its potential and improve competitiveness by building on the three key advantages - large domestic and foreign market size, its stock of well-educated population, and its undisputable wealth in natural resources - and by addressing the five key challenges - rule of law and the institutional framework, eroding quality of education, week competition environment, financial market supervision, outdated business/management processes. Finally, Gaddy and Ickes (2010) argue that Russia’s growth strategy cannot succeed only through eradicating the “typical set” of efficiency problems, i.e. weak property rights, corruption, etc. They argue that the country needs to eliminate systematic misuse of assets rooted in the inherited production structure and “oil rent addiction”. The former refers to the particular kinds of physical and human capital that were accumulated in the Soviet era and the manner in which they were allocated, including their spatial allocation. The later implies that there is an imperative to distribute a large share of Russia’s oil and gas rents to the production enterprises that employ this inherited physical and human capital.

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References Bosworth and Collins (2003), The Empirics of Growth: An Update, Brookings Institution, Washington DC Caselli (2004), Accounting for Cross-Country Income Differences, Handbook of Economic Growth, Harvard Englander and Mittelstadt (1988), Total Factor Productivity: Macroeconomic and Structural Aspects of the Slowdown, OECD Economic Studies Fischer, Sahay and Vegh (1998), How far is Eastern Europe from Brussels? IMF working paper Gaddy and Ickes (2010) Bear Traps: Can Russia Avoid the Pitfalls on the Road to Sustainable Economic Growth? Center for Research on International Financial and Energy Security, Pennsylvania State University Gollin (2002), Getting income shares right. Journal of Political Economy 110, 458–74 Gurvich et al. (2008), Cyclical Fiscal Policy in Resource Rich Countries, High School of Economics, Moscow IMF (2010) Economic Health Check, Russia: Fragile Recovery from Crisis IMF (2006), The Utilization-Adjusted Output Gap: Is the Russian Economy Overheating? IMF (2004), Domestic and global perspectives of migration to the United States, country report to the United States Doudeijns and Dumont (2003), Immigration and Labor shortages: Evaluation of needs and limits of selection policies in recruitment of foreign labor, OECD Working Paper World Bank (2007a), Unleashing Prosperity: Productivity Growth in Eastern Europe and Former Soviet Union World Bank (2007b), From Red to Gray - The "Third Transition" of Aging Populations in Eastern Europe and the Former Soviet Union World Bank (2005), Russian Federation Country Economic Memorandum World Bank (2005), Dying Too Young: Addressing Premature Mortality and Ill Health Due to Non Communicable Diseases and Injuries in the Russian Federation World Economic Forum (WEF) (2011), The Russia Competitiveness Report 2011: Laying the Foundation for Sustainable Prosperity UNFPA (2010), Social and Demographic Development in Russia: 15 Years beyond Cairo Program

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Annex I: Data Sources 1. Population by age and territory

Official, NSC RF

2. Population projections 2010-2030

Official as of 2010, NSC RF

3. Labor participation rates

Based on official employment statistics by age group, NSC RF

4. Non-oil GDP

Estimated based on World Bank CEM (2005) and Gurvich et. al (2007) “Cyclical Fiscal Policy in Resource Rich Countries"

5. Output

GDP, PPP (constant 2000 US$), WB WDI

6. Investments

Gross Fixed Capital Formation, PPP (constant 2000 US$), WB WDI

7. Capital, national Level

Capital Stock adjusted for capital utilization, PPP (constant 2000 US$), “Unleashing Prosperity: Productivity Growth in Eastern Europe and Former Soviet Union, World Bank; after 2005 calculated using perpetual inventory method

8. Capital, regional level

Calculated using actual shares obtained from official data on accounting (remaining) value of capital stocks

9. Employment by sector and territory

Official, NSC RF

10. Labor migration by territory and sector

"21 Century" Foundation/MIRPAL

11. Labor and capital shares

Official input-output table, NSC RF

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Annex II: Simulated labor deficit/surplus in Russia: Optimistic scenario 6.0 percent average non-oil-gas GDP growth, 2.5% increase in labor participation rate for optimistic population forecast, average non-oil-gas investment ratio 25 percent of GDP Output, annual average growth rate

Capital stock, annual average growth rate*

Labor, required annual growth rate

TFP, hypothetical annual growth rate

Labor force deficit ""/surplus "+" by 2020, thousand ppl.

6.0 4.0 6.5 0.5 6.0 4.0 6.5 0.5 6.0 4.0 6.4 0.5 6.0 4.0 6.4 0.6 6.0 4.0 6.3 0.6 6.0 4.0 6.3 0.6 6.0 4.0 6.2 0.7 6.0 4.0 6.2 0.7 6.0 4.0 6.1 0.7 6.0 4.0 6.0 0.8 6.0 4.0 6.0 0.8 6.0 4.0 5.9 0.9 6.0 4.0 5.8 0.9 6.0 4.0 5.7 1.0 6.0 4.0 5.7 1.0 6.0 4.0 5.6 1.1 6.0 4.0 5.5 1.1 6.0 4.0 5.4 1.2 6.0 4.0 5.3 1.2 6.0 4.0 5.2 1.3 6.0 4.0 5.1 1.3 6.0 4.0 5.0 1.4 6.0 4.0 4.8 1.5 6.0 4.0 4.7 1.6 6.0 4.0 4.5 1.7 6.0 4.0 4.3 1.8 6.0 4.0 4.1 2.0 6.0 4.0 3.8 2.1 6.0 4.0 3.6 2.2 6.0 4.0 3.3 2.4 6.0 4.0 3.0 2.6 6.0 4.0 2.7 2.7 6.0 4.0 2.4 2.9 6.0 4.0 2.1 3.1 6.0 4.0 1.7 3.3 6.0 4.0 1.3 3.6 6.0 4.0 0.9 3.8 6.0 4.0 0.5 4.1 6.0 4.0 0.0 4.4 6.0 4.0 -0.5 4.7 6.0 4.0 -1.1 5.0 *Simulated to generate average investment ratio over 2011-2030 of 15 percent of GDP

-63,253.9 -62,730.0 -62,181.4 -61,606.8 -61,005.3 -60,375.6 -59,716.7 -59,027.3 -58,306.2 -57,552.1 -56,763.7 -55,939.7 -55,078.8 -54,179.6 -53,240.7 -52,260.6 -51,238.1 -50,171.7 -49,059.8 -47,901.2 -46,694.4 -45,438.0 -44,130.6 -42,291.0 -40,353.9 -38,316.3 -36,175.5 -33,929.1 -31,575.3 -29,112.4 -26,539.6 -23,856.4 -21,063.3 -18,161.4 -15,152.9 -12,041.0 -8,830.0 -5,525.6 -2,134.8 1,334.1 4,870.9

Labor force deficit ""/surplus "+" by 2030, thousand ppl. -178,120.3 -176,156.9 -174,109.0 -171,973.7 -169,748.3 -167,430.0 -165,016.0 -162,503.8 -159,890.6 -157,173.9 -154,351.3 -151,420.2 -148,378.7 -145,224.6 -141,956.0 -138,571.4 -135,069.4 -131,449.0 -127,709.3 -123,850.1 -119,871.3 -115,773.5 -111,557.6 -105,709.0 -99,655.3 -93,403.9 -86,964.5 -80,349.4 -73,573.4 -66,654.0 -59,611.8 -52,470.3 -45,256.1 -37,998.5 -30,729.9 -23,485.2 -16,301.7 -9,218.6 -2,276.6 4,483.2 11,019.2

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Annex III: Simulated labor deficit/surplus in Russia: Pessimistic scenario 3.0 percent average non-oil-gas GDP growth, baseline labor participation rate, average nonoil-gas investment ratio 15 percent of GDP Output, annual average growth rate

Capital stock, annual average growth rate*

Labor, required annual growth rate

TFP, hypothetical annual growth rate

Labor force deficit ""/surplus "+" by 2020, thousand ppl.

3.0 0.5 3.8 0.5 3.0 0.5 3.8 0.5 3.0 0.5 3.8 0.5 3.0 0.5 3.7 0.6 3.0 0.5 3.7 0.6 3.0 0.5 3.6 0.6 3.0 0.5 3.6 0.7 3.0 0.5 3.5 0.7 3.0 0.5 3.4 0.7 3.0 0.5 3.4 0.8 3.0 0.5 3.3 0.8 3.0 0.5 3.2 0.9 3.0 0.5 3.2 0.9 3.0 0.5 3.1 1.0 3.0 0.5 3.0 1.0 3.0 0.5 2.9 1.1 3.0 0.5 2.8 1.1 3.0 0.5 2.7 1.2 3.0 0.5 2.6 1.2 3.0 0.5 2.5 1.3 3.0 0.5 2.4 1.3 3.0 0.5 2.3 1.4 3.0 0.5 2.2 1.5 3.0 0.5 2.0 1.6 3.0 0.5 1.8 1.7 3.0 0.5 1.6 1.8 3.0 0.5 1.4 2.0 3.0 0.5 1.2 2.1 3.0 0.5 0.9 2.2 3.0 0.5 0.7 2.4 3.0 0.5 0.4 2.6 3.0 0.5 0.1 2.7 3.0 0.5 -0.2 2.9 3.0 0.5 -0.6 3.1 3.0 0.5 -0.9 3.3 3.0 0.5 -1.3 3.6 3.0 0.5 -1.7 3.8 3.0 0.5 -2.2 4.1 3.0 0.5 -2.7 4.4 3.0 0.5 -3.2 4.7 3.0 0.5 -3.7 5.0 *Simulated to generate average investment ratio over 2011-2030 of 15 percent of GDP

-36,535.4 -36,118.2 -35,681.2 -35,223.6 -34,744.6 -34,243.2 -33,718.6 -33,169.8 -32,595.8 -31,995.7 -31,368.3 -30,712.8 -30,027.9 -29,312.8 -28,566.1 -27,787.0 -26,974.2 -26,126.6 -25,243.2 -24,322.8 -23,364.3 -22,366.7 -21,328.9 -19,869.2 -18,332.7 -16,717.1 -15,020.5 -13,241.2 -11,377.8 -9,429.1 -7,394.7 -5,274.5 -3,068.9 -779.3 1,592.5 4,043.6 6,570.3 9,167.8 11,830.3 14,550.7 17,320.9

Labor force deficit ""/surplus "+" by 2030, thousand ppl. -86,214.0 -84,999.3 -83,732.5 -82,412.0 -81,036.1 -79,603.0 -78,111.2 -76,559.1 -74,945.0 -73,267.5 -71,525.1 -69,716.3 -67,840.0 -65,894.9 -63,880.0 -61,794.4 -59,637.3 -57,408.2 -55,106.7 -52,732.9 -50,286.7 -47,768.7 -45,179.5 -41,590.2 -37,878.1 -34,048.4 -30,107.3 -26,063.0 -21,925.0 -17,704.6 -13,414.9 -9,070.8 -4,689.1 -288.2 4,111.6 8,488.6 12,819.8 17,081.2 21,247.7 25,294.5 29,196.6

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Annex IV: Simulated labor deficit/surplus depending on TFP growth rates in Central and North-West Federal Districts

Source: own calculations based on data from NSC RF, WB WDI database, and dataset from World Bank (2008)

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