Despite vigorous recovery efforts, the Russian economy has yet to fully rebound from the 2022 downturn. According to Rosstat data, by the end of the second quarter, GDP had reached only 98.9% of the pre-war fourth quarter of 2021 level. Industrial production had only slightly surpassed pre-war levels. At the same time, real incomes of citizens continue to rise, especially wages. According to Rosstat, in June their growth in annual terms amounted to 10.5%. However, Alexander Isakov, Chief Economist for Bloomberg Economics, calculates that two percentage points of this increase can be attributed to the sampling shift used by Rosstat. Nevertheless, even if this is the case, the jump is quite impressive, particularly given the economic constraints.
The full-scale invasion of Ukraine coincided with the period of income recovery following the COVID crisis. Noticeable income growth in 2021 (+3.9%) turned into a decline in 2022 (-1.5%). While the scale of income reduction in 2022 was comparable to the COVID crisis, its structure differed, as noted by experts from the Center for Macroeconomic Forecasting (CMACF). During the COVID crisis, there was more amplitude in the growth and decline of individual income components, with some components decreasing while others increased. In 2022, all income components contracted, primarily due to a surge in inflation triggered by sanctions and the collapse of the ruble. In the second and third quarters of 2022, real wages decreased by 5.4% and 1.9%, respectively, compared to the same periods of the previous year.
However, in the first half of 2023, income dynamics became positive once again, thanks to real wage growth, the strengthening of the ruble, and disinflation. The accelerated wage growth was a response to two simultaneous factors: first, the outflow of workers from the labour market due to emigration (relocation) in 2022 (Re:Russia estimates that at least 800,000 people left Russia) and 'partial mobilisation’. Various assessments suggest that mobilisation or contract service led to at least 300-350,000 people being called up to fight. In this case, the combined labour market outflow may have exceeded 1 million people, approximately 1.5% of all those employed in the economy. This represents a significant change, especially against the backdrop of traditionally low official unemployment and limited labour mobility in Russia across regions and sectors. The second factor was the strong budgetary demand in the defence sector, which required a significantly expanded workforce.
These two factors have created a talent scarcity and fierce competition for workers. In a September report on 'Regional Economics,' experts from the Central Bank note that, according to a survey they conducted, 60% of companies are complaining about a shortage of employees, mainly those with specialised skills. As a result, 75% of these companies have found themselves compelled to increase wages. Predictably, the primary surge in wages has been concentrated in sectors where the talent shortage was most keenly felt. According to analysts at the Center for Macroeconomic Forecasting (CMACF), the leader in the first six months of 2023 was the manufacturing industry, which witnessed a remarkable growth rate of +9.5% compared to the same period last year. This growth was particularly pronounced in subsectors linked to the military-industrial complex. For instance, in the production of electrical equipment, the growth rate reached 18%, while in the manufacturing of computers, electronic, and optical products, it was 16%. Similarly, clothing production and manufacturing of other vehicles and equipment saw a 15% increase in wages. Thus, the CMACF experts note that the wage race was ignited by the public sector, primarily defence enterprises, and private companies were compelled to respond by also raising wages.
In principle, according to some economists, this preemptive wage growth redistributes income in favour of workers and can potentially create conditions for stimulating the economy through increased private domestic demand. Renowned economist and visiting researcher at the Harvard University Davis Center, Andrei Yakovlev, is of this opinion. However, other economists have pointed out that wage growth outpacing productivity growth can lead to reduced competitiveness in domestic production, a phenomenon often associated with import substitution policies.
If we look at the dynamics of industrial production and wages in the long run, the situation does not look particularly dramatic. The dynamics of real wages lagged behind due to ruble devaluation. The outperformance of wage growth in 2023 is similar to a similar episode observed in 2017 and early 2018 (both episodes occurring on the eve of the presidential election in Russia): wages are rising in line with industrial performance. Following the same logic, the ruble devaluation in July-August of this year is expected to dampen the rapid wage growth in the first half of the year.
However, we should bear in mind that the nominal recovery of production levels in 2023 masks significant structural changes: over the past year, production associated with the defence industry has grown at a faster pace, while the consumer sector of the manufacturing industry recovered at a slower rate. As a result, the production of products that can be consumed in the domestic market lagged significantly against the backdrop of faster wage growth.
These circumstances, compounded by the expansion of consumer lending, have become one of the factors contributing to increased inflationary pressure and economic overheating. In July, monthly price growth accelerated to 12.2% compared to 5.6% in June, as noted by experts from the Central Bank in their September ‘What the Trends Say’. Annual inflation rose from 3.25% to 4.3%, surpassing the 4% target.
Following a sharp increase in the key interest rate, we should expect a slowdown in economic growth, as Re:Russia has previously highlighted. However, the labour shortage will not disappear, caution experts at CMACF. The budget-financed demand for the production of goods needed for the war effort will persist, along with the competition for labour in these sectors. Any slowdown or halt in growth will primarily affect the consumer sector, which will face difficulties in accessing credit. As a result, the demand-supply imbalance will persist and complicate the government's fight against inflation. The situation will also be influenced by a decrease in the availability of consumer credit due to rising interest rates. However, in this scenario, the contraction of demand will further limit the consumer sector of industry.
One way or another, the cycle of stimulative policies from late 2022 and early 2023 appears to have come to an end, with the labour market deficit becoming a crucial factor limiting the effectiveness of these stimulus measures.