HOW WILL RUSSIA’S CONSUMER MARKET DEVELOP?

By A. I. Kolganov

Russia’s economy still depends to a considerable extent on the state of the world’s markets for raw materials and energy, and especially oil. However, it is the state of the internal market that has the greatest effect on Russia’s economic development. Now that the favorable macroeconomic situation which developed in early 1999 has to a considerable extent exhausted its influence on economic growth, the continuation of that growth depends largely on the dynamics of the consumer market.

A LOOK AT THE PAST

In the Soviet era, and until the beginning of the radical market reforms, Russia’s consumer market was characterized by a whole range of features which, in varying degrees, continue to influence the evolution of the current consumer market. The Soviet consumer market was able as a rule to satisfy the demand for the major foodstuffs, though there was some shortage of fruit and vegetables and higher quality foods.

Almost all urban families had access to consumer goods such as televisions, refrigerators and washing machines. (Almost all rural families had televisions, but by no means all had refrigerators and extremely few had washing machines.) However, technically these were noticeably inferior to world market standards. As for the supply of the latest durable goods such as PCs, microwave ovens, video recorders and dishwashers, the Soviet Union lagged far behind developed nations. The same was true of automobiles.

The Soviet Union fell significantly short of satisfying the demand for housing. In terms of the area of living space per person, the Soviet Union was 1.5 to 2 times worse off than developed nations.

The provision of many services was also at a very low level. For example, even in the cities the coverage of the telephone network was inadequate and the technical equipment used in the service sector was extremely outdated.

The Soviet Union’s consumer market was characterized particularly by an imbalance between supply and demand. With prices fixed by the state for most goods and services, disposable income exceeded market supply, resulting in shortages of many goods. The time spent by shoppers searching for essential items in the shops was extensive, amounting, according to some estimates, to a third of the individual’s free (that is, nonworking) time. This situation became especially acute on the eve of the radical market reforms of 1990-1991.

MARKET LIBERALIZATION AND CHANGES IN NATURE OF DEMAND

The liberalization of the consumer market in January 1992 had contradictory consequences. On the one hand, unregulated market prices soon restored a balance between supply and demand, and put an end to shortages of the overwhelming majority of goods and services. There was a marked increase in consumer choice. This was happening, however, against a background of high inflation and income squeezes for most of the population. So while supply shortages were being overcome, there was an accompanying reduction in the absolute level of demand for most goods.

There was a significant deterioration in the structure of demand for foodstuffs–while the proportion accounted for by consumption of bread, potatoes and sugar grew, the absolute level of consumption of these items fell.

At the same time, demand for certain goods of which there had been a significant under-supply in the Soviet period increased because these goods were becoming available at relatively low prices. This included audio and video equipment from China and South-East Asia, PCs which began to be assembled in Russia from parts bought in from South-East Asia, and cheap second-hand automobiles, imported from Western Europe and Japan. People on high and medium incomes were now able to satisfy their previously frustrated demands for such goods.

The continuing significant demand for housing from high-income groups meant that the domestic construction industry could be maintained at a level which, though lower than in the Soviet period, had still not fallen as far as the main economic indices.

In the service sector, free education and healthcare funded from the state budget were gradually replaced by chargeable services. The take-up of these new services by low-income groups diminished, while demand from high-income groups increased. There was an expansion in the provision of various chargeable services aimed at high- and middle-income groups. Thus, for example, there was significant growth in the market for overseas travel services. At the same time, the domestic tourism industry, targeted at those on lower incomes, contracted substantially.

The dynamics and form of people’s savings were of a curious nature. In the hyperinflation of the early 1990s most people lost almost all of their savings. They subsequently sustained further considerable losses as a result of the financial activities of a large number of corrupt companies. Consequently, the most popular method of keeping personal savings became the accumulation of cash in freely convertible currencies, chiefly the dollar.

In the mid-1990s, with the economic downturn slowing, incomes stabilized and savings began to recover. In 1996-1997, people on high and medium incomes began to increase the proportion of their savings kept in the form of bank deposits. But the financial crisis of August 1998 and the associated failure of a number of banks led to a resurgence of savings in the form of foreign cash.

These contradictory consumer dynamics were governed largely by the marked income differentials seen across society. Whereas the ratio of the income of the richest 10 percent to the poorest 10 percent of the Russian population was 6:1 prior to the market reforms, in the mid-1990s the figure was 15:1. There was a sharp growth in regional income differentials too, and a widening gulf opened up between the wages of workers employed in different sectors. The number of people living below the poverty line fluctuated at around 22-31 percent of the population. The poverty line itself was defined as the level of basic physical subsistence, but the average pension was below the poverty level and agricultural wages were less than pensions.

GROWTH OF CONSUMER MARKET AFTER 1998 FINANCIAL CRISIS

The financial crisis of August 1998 and the fourfold devaluation of the ruble that followed resulted in an almost instant drop of 30 percent in incomes in real terms, and 40 percent in wages. However, by a paradoxical conjunction of circumstances, this did not bring about the collapse of the internal market.

Neither the devaluation of the ruble nor the fall in demand was conducive to the import from abroad of a wide range of consumer goods, and their place in the market was taken by domestically produced goods. In the first instance, this shift promoted an increase in internal production of foodstuffs, clothing, footwear and, to a lesser extent, electrical household appliances.

Increased internal production coincided with a considerable increase in the price of oil and several raw materials on the world market, which improved the state of the Russian budget and led to greater demand from the raw materials and extraction sectors for the output of the domestic processing industry.

As a result, this economic growth produced a rise in real incomes in 2000 and 2001 of 10 percent and 8 percent respectively. The most rapid increase was in the incomes of the most affluent groups, engaged in entrepreneurial activities. But there was also a rise in the real wages of hired workers and an increase in welfare spending financed by the state budget. Taken together, this all contributed to a substantial growth in the domestic consumer market.

Since the incomes of medium- and high-earners grew faster, these were the groups that dictated the changing shape of consumer demand. After the 1998’s sharp fall in consumption, 2000 and 2001 saw a revival in demand for electrical household appliances and automobiles. There was a particularly sharp rise (of about 50 percent) in demand for furniture, which considerably outstripped the general growth in income. The demand for high-quality housing increased. The broadening of demand for higher education even resulted in an absolute increase in student numbers. This can be attributed to market requirements for special skills corresponding to the needs of the market economy. There was a boom in the number of young people wanting to train as professional economists, managers, accountants, auditors, lawyers, IT specialists and so on.

According to the experts, though, despite this consumer growth, expenditure by the middle and upper classes on accommodation and automobiles is nevertheless still insufficiently high. This is due to their relatively low levels of savings and the extremely underdeveloped consumer credit environment.

LIMITS OF CONSUMER MARKET GROWTH

With the period of high world oil prices at an end, the growth of the internal market is becoming the main determinant of Russia’s economic growth. At the same time the growth in internal demand is itself dependent on the prospects for economic growth in general. Overall, it seems most unlikely that incomes will stop growing in real terms in 2002 and 2003. For both entrepreneurs and hired workers, however, income growth will slow down, as will the growth of welfare allowances financed from the budget.

Continuation of the policy of increasing nominal incomes is closely linked with the government’s projected education and housing and utility reforms, which envisage some growth in expenditure by the population in these sectors. In addition, in 2002 a 35 percent increase is projected in prices and tariffs for the products and services of the natural monopolies.

The clear signs of a slowdown in demand have begun to nudge producers and vendors towards increasing their use of consumer credit. The first schemes for long-term housing credits have appeared, and in 2001 the major Moscow suppliers of electrical household appliances began offering an extensive program for credit purchases.

But even if a significant part of the growth in nominal incomes is not swallowed up by price increases, the expansion of real internal demand will have contradictory effects on the Russian economy. It should be borne in mind that those groups with the fastest growing incomes, who are responsible for generating most of the demand within the domestic market, are refocusing their purchasing from items of domestic production to foreign goods as their incomes increase.

The growth in consumption by the middle class in 1999-2001 has been characterized by a shift in the balance of demand for almost all goods (except, in general, for foodstuffs) in favor of foreign-produced goods. The “average Russian” has, to an ever larger extent, been buying a Korean Daewoo, a Czech Skoda, or a secondhand model of a more prestigious make in preference to a Russian-built Zhiguli. Instead of a Russian or Belarusan television set, he has been buying a Korean Samsung or LG or a Japanese Sony or Panasonic (it doesn’t matter that these are assembled in China or Malaysia). The markets for furniture, clothing and footwear have long been dominated by imports.

Thus, growing demand increases the requirement for imports of consumer goods from abroad, reduces the desire for domestically produced consumer goods and needs an increase in export revenues to finance the growing imports. But export revenues will inevitably shrink along with the fall in world oil prices. This will result in a slowdown or even a halt in the growth of imports in real terms, increased prices for imported goods and a still greater slowdown in the growth of real consumption.

Is this situation likely to generate a swing back to demand for domestically-produced goods? This depends on the ability of Russian producers to make their goods more competitive. But this cannot possibly be achieved unless production techniques are modernized, which requires large-scale investment. And investment levels, which were already insufficient, have slowed down in recent months.

Without changes in the general economic situation, it is hard to see how the rapid growth in consumer demand and the expansion of the consumer market can continue. The increase in nominal incomes is not in itself capable of guaranteeing a growth in real consumption: This will require either high export revenues, sufficient to finance the growing influx of imported goods, or increased availability of competitive domestically-produced goods. Unfortunately, neither of these can be expected in the next twelve to eighteen months.

Andrei Kolganov is a doctor of economics and a senior research fellow at Moscow State University.