In the past several months, prominent economists and government officials have proposed reenergizing Russia’s economy through massive state investment in infrastructure.
Former First Deputy Minister of Economic Trade and Development Mikhail Dmitriev has actively promoted the idea of investing at least 3 percent of GDP in infrastructural projects annually, arguing that doing so will result in long-term GDP growth of 3 percent per year.
In high-level economic discussions, officials erroneously point to state investment in infrastructure as the reason for FDR’s success in pulling the U.S. out of the Great Depression and the German economic boom in the 1930s.
Are state-funded infrastructural projects the answer to Russia’s economic problems?
Although state investment in infrastructure and economic growth are often correlated, government investment is not always the cause of growth. In order for investments in infrastructure to be successful, they must correspond to existing or potential market demand. Past attempts to use infrastructure investment to energize the economy—notably in some African countries—succeeded when demand for infrastructure from business greatly exceeded supply.
This kind of investment is most effective when there is very little existing infrastructure and demand for development is high. In countries with relatively good infrastructure, such as Russia, the effect is much smaller. In many cases, “successful” government investment in infrastructure is actually undertaken in response to a growing economy.
Infrastructure is not the limiting factor inhibiting Russia’s economic growth. High transportation, communication, and logistical costs pale in comparison to the to bigger issues businesses face, including the absence of the rule of law, the lack of legal protections for investors and entrepreneurs, political uncertainty, and corruption. Moreover, Russia lacks the capital and labor resources necessary to fuel rapid economic growth.
In such an economic climate, large-scale government infrastructure projects are bound to face a number of challenges.
Cronyism is an obvious barrier to development: the government will almost certainly invest in projects that are lucrative for the most successful lobbyists—with close ties to the government—rather than in those that best serve the public good.
Financing will also be problematic. If previous investment is any guide, future infrastructure projects will be overpriced and over budget. What’s more, a large portion of the money earmarked for investment will inevitably flow offshore, further undercutting the ruble exchange rate.
Implementation can be expected to be slow and to violate quality control standards. As a result, some of the infrastructure built will be inefficient, if not useless. The government is unlikely to make the necessary investment into maintenance, meaning that projects that do get off the ground will have short lifespans.
Large-scale infrastructure projects are likely to have a net negative effect on overall demand: funds for investment will be raised through monetary emissions, which will lead to inflation and a decrease in demand, further reducing the utility of the projects.
The diversion of resources into state infrastructure can be expected to increase costs for independent businesses: due to the shortage of human capital, government investment will be a drain on materials and labor, which will raise prices and wages.
Domestic reform will likely suffer as a result of large-scale infrastructure investment. The monetary emission-driven investment will offer elites a brief opportunity to make money and, yet again, postpone reforms. Russia’s development will begin to lag even further behind its competitors.
Russia’s foreign policy will probably become more aggressive in order to compensate for the aforementioned economic problems and their negative effect on the government’s approval ratings. This will in turn impair Russia’s ability to attract investment and further divest Russia from the global economy.
Even if all of the above challenges were addressed and there were significant demand for infrastructure in Russia, it would still take a colossal amount of government investment to invigorate the economy: in order to for GDP growth to reach 3 percent per year, Russia would need to increase state investment by 36 percent the first year, increase the initial investment by 18 percent the following year, 9 percent the year after that, then 4.5 percent, and so forth.
This means that government investment would have to grow by 3.7 times for GDP to grow 3 percent per year. Considering that 50 percent of all money allocated for infrastructure projects is lost to corruption and inefficiency, however, investment would probably have to be increased more than sevenfold to hit this target.
Conservative estimates suggest that Russia would have to invest 15 percent of its GDP in infrastructure annually for many years to have a significant effect on the economy. This is impracticable: by way of comparison, Mexico spends 5 percent of its GDP on infrastructure, India spends 10 percent, Indonesia spends less than 7 percent, and China spends between 6 and 11 percent.
The Russian economy has two fundamental problems: excessive regulation and high risks that disincentivize doing business. Economic growth will require either very high potential earnings for businesses or a dramatic decrease in the risks of doing business. Investment in infrastructure does nothing to address either issue, and therefore is a poor antidote to Russia’s economic ailments.
