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#24 - JRL 9244 - JRL Home
Date: Tue, 13 Sep 2005
From: Sergey Slobodyan <Sergey.Slobodyan@cerge-ei.cz>
Subject: Re: 9242-Johnson's Russia List #15

Sergey Slobodyan, Assistant Professor (Economics), CERGE-EI, Prague:
Re: Sergey Minaev, Russian economy became as free as the economy of Africa
, Kommersant, September 12, 2005

Reading this material leaves anyone familiar with Russian economic situation deeply perplexed. Russia as economically free as Togo? Russia being the worst on the "Access to Sound Money" scale? These numbers are too incredible to accept them at the face value.

Let us take just one of the five Areas comprising the Index, "Access to Sound Money". It consists of 3 objective components: Growth of Money Supply, Inflation Variability, and Recent Annual Inflation, plus an index of Freedom to Own Foreign Currency. Russia gets 3.8 overall (0 is the lowest and 10 the highest), with 3.1 for money growth, 0 for inflation variability, and 7.3 for recent inflation. Remarkably, the grade for inflation variability in 2003 was lower than in 2000, 2001, and 2002, and the overall "Access to Sound Money" grade was higher in 2002 than in 2003. This despite the fact that inflation in Russia was falling, not rising, in years 2000 to 2003. Does this sound strange? It does indeed.

Inflation variability is simply the standard deviation of five latest annual inflation numbers taken from the International Financial Statistics, IMF. Calculation for 2003 includes a very high number recorded in 1999, 85.7%, and a string of rapidly falling numbers: 20.8%, 21.5%, 15.8%, and 13.7%, all very different from 85.7; the resulting standard deviation is very high at 30.5%. 2002 formula uses 27.7% for 1998 and drops 13.7% for 2003, making the whole set of five numbers more uniform and generating slightly lower standard deviation. For the next year, the number 85.7% will not be part of the formula, producing very low inflation variability and a very high score of 8.3 instead of the lowest possible 0 as in the current 2003 Index of Economic Freedom. Lower 2004 inflation will give about 7.8 for "Recent Annual Inflation" instead of the current 7.3. Keeping all other numbers the same, Russia is set to get 6 out of 10 on the "Access to Sound Money" and 5.5 to 5.6 overall Index in the next year, finding herself among such countries as Cameroon, Macedonia, Ukraine, and Vietnam.

The way the Index is calculated makes Russia much more "un-free" than it is simply because the financial crisis of 1998 is still used in calculations, even though it is all but forgotten by international financial markets and the rating agencies. Index also penalizes Russia for high rates of money growth, which are inevitable given the very low monetization rate of the Russian economy. Book "Russian Economy in 2004" published by the Institute for the Economy in Transition (Gaidar Institute) claims on p. 38 that "according to the results of 2004, monetization of GDP increased merely from 24.3% of GDP up to 26.0%, but it still remained low. ... such situation maintains high enough growth rates of money supply, which has no adverse effects at least until monetization of GDP reaches 35 to 40% ...".

Usefulness of scores in some other Areas raise questions as well. For example, on Area 1 score, "Size of Government", Russia (5.4) is sandwiched between the currently suffering from famine Niger (5.2) and barely existing as a united country Democratic Republic of Congo (5.6), while very successful European countries range from very low (4.2 in Denmark) to very high (7.3 in Switzerland) scores. Nigeria gets perfect 10 in a component "Government Consumption" of this Area, and very respectable 6.3 for the "Size of Government" (yes, Nigeria is also more economically free than Russia; presumably, this is the reason why my spam filter detects many more offers of money transfer from relatives of deceased Nigerian politicians than from Khodorkovsky's lawyers).

Given the Index's methodology, one is led to believe that very high but stable inflation rates might be as good as rapidly falling ones, that countries with low monetization of GDP should not attempt to increase it, and that imitating budgetary choices of countries balancing on the verge of failure is a virtue. One does not need to be an economist to have a different opinion.