Authors of the report – Maxim Kozyrev, Aleksey Moshkov, Kirill Rumyantsev
Economic crisis has passed its first stage when cost parameters of those kinds of activity that used to be habitually profitable and steadily growing, became subject of correction.
Nevertheless there was no alignment of economic patterns along with new circumstances as it could never happen. It means that a lot of problems appeared and new ones keep on showing themselves. Still none of them has been solved. Some are being under the process of searching for a solution in a small extent or even just under discussion.
The fire of appearing problems is traditionally flooded with money flows. For instance, USA received “injection” of $100 trillion within crisis period. Our scales are meager but it concerns our economy which is by an order less. One couldn’t see these money circulation on market because emitted and distributed means (USA dollars primarily) proceeded to the same structures and bodies whom one must be grateful for previous rise and crisis. It happened in order to provide them with assets to meet their actual engagements.
Cleanup of the market from structures not corresponding with forming cost parameters will be performed through alignment of those structures with new terms and conditions as well as through withdrawal from the market performed by those who cannot adapt due to objective or subjective reasons and have to declare bankruptcy.
In the second case we face a new question – if such withdrawals and escapes are going to be concentrated within the period of the second crisis wave or if they are to happen slowly one by one while smoldering depression with continuing recession in certain branches and local rise in other ones – there is no clarity yet. It is quite possible that in various countries there will be different ways of development of this situation.
Independently on chosen way to go out from crisis, return to old established conditions of economic and commercial operation is never to happen. In midterm perspective economic world will not seem so tranquilly, steadily and dynamically growing and developing without any alternatives as it used to be perceived during the years of previous upswing.
By-past crisis has shown pyramidal financial structure of the world economy as well as its inner controversies, accumulation of long-term problems and absence of quick methods of finding their solution.
Despite any scenario of surmounting the crisis in many separate branches and in economy in general situation will stay undetermined and instable for rather long time. And it is to clarify for midterm period only when steady raise phase begins again and it seems that nothing threatens this growth. It means – not so soon.
What all of these means for an investment manager?
He won’t be able to rely on externally given ideas of economic situation expressed in relevant model of environment with steady parameters in which framework a project needs to be elaborated, as secure as before. Investment manager will have to form the picture of the world himself regarding economic circumstances of project implementation and correct it according to appearance of new evidence.
With respect to this we would like to share what we know and comprehend concerning significant features and tendencies of Russian and world economy that were born during the crisis and will stay in force once it’s gone.
In order to be sure we understand each other promptly, let us remember and discuss basic notions of economic and financial studies.
2. What is Economy? Structure of the world and national economies.
Economy (economical activity) is an aggregate of various activities by means of which people meet their demands for economical goods or amenities.
Economical amenities are those that cannot be taken out from nature without making efforts of demander or other peoples’ efforts. Spending energy and using other available resources while economical activity people produce economical goods in overall amount corresponding with energy, etc. they’re ready to sacrifice in order to own these goods.
People have various skills and knowledge as well as possess technologies of these goods production in different extent. They inhabit all continents and countries unequally provided with natural and accumulated capital resources. Therefore labor division among them for the goods production as well as further exchange of labor products in general appears to be more efficient than production of each single good and service separately. This concerns either division of labor on the shop floor or within division of economy of a whole country into branches as well as it happens in the world economical system in terms of which industry or functions become preferential or turn into specialization of certain states. Distribution of branches and functions among different countries reflects the world economical structure and determines the structure of national economy in each country within it.
Economical factors specify incomes, expenditures and profits of economic entities as follows:
- incomes as an intersection of amounts and prices of produced goods and services,
- expenditures as an intersection of amounts and prices of resources used for production and offtake of these goods and services,
- profits and losses as the difference between incomes and expenditures.
3. Main factors of the world economy influencing the situation in Russian economy.
The world economy nowadays appears to be globalizing one which manifests itself in strengthening concurrence and cooperation of growing amount of economic entities of certain countries with other entities from the whole world. This concurrence is a competition for better supply of demand, production of best goods as far as optimal value for money is concerned, best performance of functions for goods production and provision of services for that very part of the population demonstrating this purchasing power.
Standardization of produced and consumed goods and services has induced a lot while recent decades in various countries. Costs of goods transportation between these countries reduced, on the opposite. It resulted in the situation when each economic entity has less opportunity for natural monopoly on some territory for production and disposal of its goods and services just due to this fact that it’s situated on this territory. Countries more and more share not branches but functions they perform in those branches.
Because of domination of capitalistic system all entities within it press for maximization of their income and minimization of expenditures in order to gain all possible profits. This is why specialization of countries and regions slowly shifts to those very functions which implicate minimal expenditures with equal quality of their performance. With respect to this fact labor division within modern globalizing economy becomes not only total and really global but also functional instead of branch one. It means that labor is divided not on the basis of producer but also depending on the function performed while this production.
According to more and more complete inclusion of developing countries, especially from South-Asia, i.e. China, India, Vietnam, Indonesia, etc, into the world labor division as competitive ones, in terms of expenditures and quality of industrial goods producers, aggravation of contradictions because of unequal labor costs of similar quality becomes more evident. Due to the fact that the basis of low cost of performing functions by South-Asian countries is inflow of cheap labor forces from agrarian sector along with industrialization of this region, and that sector still remains really huge, this tendency is only to rise. Production functions in growing number of branches are to become the subject of specialization of South-Asian countries covering new and more complicated branches.
States with labor cost higher than in South-Eastern Asia (it means not only developed capitalistic but also post-socialistic countries) become less competitive in terms of performance of production functions. Enterprises of these countries are not modernized, as it’s not profitable – once being modernized they are able to produce goods of higher quality but also of much higher cost than those being imported from South-Asian region. Therefore, industrial sector is winded down.
During last decade in order to provide employment of the population in developed countries they even perform functions where these states are out of competition because of unreasonable expenditures. Sequence of support given to these non-competitive functions in developed countries is overstated consumption in relevance to produced volumes of added value. For some time sources of funds for covering losses occurring because of that activity were accumulated capital reserves and well-known pyramids of financial market which problems became the trigger of current financial crisis.
4. The state of affairs in Russian economy.
Significant part of demand (consumers as well as productive) is supplied by means of import in Russia. Main income source for payment for this import is export of natural resources (particularly energy resources and metals). Majority of goods imported to Russia have no counterparts among local production in terms of quality and price. Russian production is not competitive at all. Most of enterprises have been preserved since Soviet Union period due to insufficient involvement of Russia into the world economical concurrence and also because of low funding of costs of reproduction of main depreciable means of production that were falling into decay but never renewed.
Many goods produced in Russia have got behind and keep on staying in this condition comparing to imported analogues as far as quality is concerned. Meanwhile manufacturing feasibilities where these goods are produced are completely out-of-date either from technological or material point of view. By this very moment there are no manufacturing feasibilities in Russia that could provide replacement of import. In 1998 such enterprises existed and due to ruble devaluation those standing idle were loaded and replaced import by their outcome. However while the period of economic upraise they were degrading without being reproduced.
Technical lag behind leads to the fact that Russian goods are not competitive not only regarding quality but also in terms of price even in spite of their production needs lower costs for energy and labor. Depreciation of main means results in excessive expenses on maintenance of their working capacity.
5. Investment perspectives for Russian economy.
Industrial sector in Russia is to become be less and less efficient but keeping its social role of preserving employment of the population. Accomplishment of this role will demand constantly growing volume of redistribution of income, received from the export of raw materials, in it’s favor as expenses for preserving social sector will also increase. At the same time there will be no significant rise of raw materials income. Growth of expenses in order to preserve social sector is to lead to strengthening of its noncompetitiveness, further reduction or even termination of activity in a number of industrial branches. Meanwhile accumulated depletion of equipment increases risks of exploitation of the main means, therefore in export-income field and connected with it branches as well as in life-supporting ones re-equipment will start which in its turn is to cause rise of demand for investment goods. However it will be found out that many of them simply cannot be produced in Russia and recovery of their production is extremely expensive.
Relatively inexpensive investment projects are to become more and more popular for population and state as their implementation will allow support normal certain level of employment with less expenditure of resources than needed for maintenance of industrial sector in its actual state. Also projects focused on income increase from raw material resources disposal will be eagerly-sought. Such projects can be efficiently implemented in the following directions:
- enhancement of efficiency in raw materials sector
- optimization of expenditures in the branches, excluded from concurrence within the world economic system due to natural reasons (high transportation costs, bonding to certain market outlet, etc)
- reduction of raw materials resources consumption within a country (for example, nuclear power development, increase of efficiency of energetic infrastructure and so on)
- development of industrial branches artificially protected from competition within the world economy with the purpose of provision of employment and support of necessary level of sovereignty of the state.
Herewith artificial protection of certain industrial branches from concurrence within the world economy is possible on the level of one state only. Therefore selection of sectors to be protected is to be performed by the state with some contribution from businessmen being interested in development of certain branches, and probably employees of these sectors once they’re organized enough and determinate for defense of their interests.
During the period of cyclic conjunctural upraise which is to follow the crisis in Russia so called “speculative investment projects” will appear as it happened before, the ones that exteriorly may seem attractive and reasonable for investor, while practically they are neither implementable nor efficient when being completed. But if one exits from the project on the stage when its inefficiency has not revealed yet, the whole idea may appear as an interesting source of profit for investment speculators.
As far as significant volume of accumulations made within USSR period has already been turned to income and consumed, amount of projects focused on investment and “capitalization” of existing industrial and trade enterprises, and resources volume which it’ll be possible to attract for them, is going to be less then similar one within previous growth period. That is why it’ll be really possible to attract resources for the projects that appear as early as possible and therefore will seriously exceed competing ones.
Within first years of post-crisis development mismatch of real tendencies and processes in Russian economy and rhetoric of the ruling elite will obviously escalate. The latter will keep on declaring necessity of innovative development even though there will be less resources for this than in previous upraise. Therefore inexpensive investment or pseudo-investment projects will appear to be eagerly sought and supported by the state authorities. Start and wide popular presentation of such projects will highly correspond with PR goals of state innovative policy.
Enclosure. General logic of medium-term cyclic development of economy.
Economy always develops cyclically. Cyclic crisis is a normal termination of medium-term economic cycle of 8-10 years. Usually such crises deal with one or several world regions as it happened for example in 1998 when South-Eastern Asia, Russia, Brazil and some more countries were struck.
General scheme of an economic crisis looks like the following:
1) Upraise stage:
- Market growth (volumes of consumption and prices)
- Investments into production and commercial facilities for supply of increasing market demand
- The feeling of insatiability of the market and longevity, euphoria
- Beginning of less efficient and profitable only in case of high prices projects, growth of resources costs, falling projects efficiency
- Creation of abundant production, trade and other capacities
- Expectation of profitability due to growing prices and volumes what in fact means accumulation of losses
- Coverage of losses by growing credits and loans.
2) Crisis and decrease stage:
- Accumulated losses allow financing current activity only in case of constant increase of mobilized funds
- Appearance of creditors and investors’ anxiety regarding repayment of mobilized money
- Finance retrenchment
- Increase of the number of companies that cannot meet their obligations, have technical defaults and overdue indebtedness
- Momentous event – a huge and representative company considered very reliable before has no capacity to apply its undertakings - this causes conveyance of this case to others and revision of evaluations in negative direction.
- Avalanche-type growth of bankruptcies as a sequence of cut down of investment flow along with obligations presented to be satisfied
- Reduction of expenses, general decrease of activity
- Assets stop generate money flow sufficient for investments effectiveness demonstration
- Assets are devaluated by the level where money flows generated by these assets do not give adequate output to investments
Still meanwhile new opportunities of business activities appear which successful tryout lead to new upraise.