Russian Income Growth: Lagging Behind or Lurking in the Shadows?
In Q1 2011, Russian retail sales accelerated despite stagnant real wages and disposable income, continuing a perplexing trend. In fact, retail sales have grown faster than wages in 9 of the last 10 months, a full 5% faster over the last year. The question for medium term forecasts is, will this trend continue? If it is just Russian consumers digging into their savings or taking on new debt, the trend must reverse itself as consumers get tapped out. But if this trend is supported by unofficial income sources, then perhaps household consumption can continue to power Russian growth. In this analysis we look to see whether a change in Russia’s tax code in 2010 and 2011 caused a spike in ‘informal’ employment and wages, which could explain this disconnect and support the trend going forward. We find little evidence that this is the case, suggesting that either spending will ease or household debt levels will rise.
The case for sustainable spending growth
Many analysts argue this trend in consumer spending reflects growth in Russia’s “shadow economy.” If consumers are getting increased support from under-the-table compensation, then spending might not be outpacing wages by as much as official statistics suggest, and retail sales can remain high for the foreseeable future.
It is a tempting explanation. In 2010, the new Social Contribution Tax (SCT) increased the tax burden on low-income workers. Then in 2011, the rate on the SCT was increased from 26% to 34%. It would make sense, then, for employers to pay more of their workers under the table to avoid the new tax.
It makes sense, but is it true?
Of course, the size of the shadow economy cannot be measured directly. Economists do have a number of ways of estimating that size, but they typically rely on assumptions that don’t quite reflect reality. One way is to compare macro data on income and expenditure: it’s easier for an individual to hide his income than for a company to hide its sales, so if people are spending more than they claim to earn they are probably earning more than they claim. This of course relies on accurate data, something Russia isn’t famous for. An alternate approach assumes that the labor force participation rate is constant, and therefore any drop in that rate instead represents workers moving from above-ground to underground employment. Unfortunately, the idea that there are no “discouraged workers,” or at least that their number is fixed, is untenable in the long term.
Fortunately, the recent changes to the tax structure give us a way to reduce the time scale of our model in a way that helps make these assumptions a little more palatable. This sudden, structural change should create a similarly sudden shift in the size of the underground economy, one that happens almost overnight the day the tax change went into effect. Over the extremely short term, the otherwise heroic assumptions that the income/expenditure ratio or the labor force participation rates are fixed aren’t nearly so hard to swallow.
So if we look at these ratios in the month, quarter and year on either side of the January 1st changes in the tax structure, the evidence does not support an increase in the size of the shadow economy. An increase in unofficial income should raise the ratio of money going out (retail sales and personal deposits) to money coming in (official wages and personal loans). But looking at that January-December change, the ratio has in fact been fairly flat. There are no marked changes in January, nor is the ratio particularly high in 2010/2011 relative to recent years. Consumer spending is up relative to wages, yes, but this reflects a slowdown in savings due to negative real interest rates (which dissuades savings) and rising confidence (which reduces precautionary savings) Russian consumers have tended to reduce savings in times of high inflation in the past (including in 2007-8).
Figure 1: Retail Sales and Deposits as Percentage of Wages and Borrowing
Source: EMED
An alternate approach looks at the labor force participation rate, working on the assumption that that ratio is fixed and any apparent drop represents workers moving to unofficial employment (an assumption that is easier to accept on a month/month basis than more long-term). Evidence from this approach is similarly unconvincing. Labor force participation dropped in 2010 and 2011 despite falling unemployment, which would tend to encourage rather than discourage workers. But it has fallen in seven of the last ten Januaries, and (with the exception of the q/q figure) the drop is not unusually large.
Figure 2: Change in Labor Force Participation Rate (per economically active population)
Source: EMED
All in all, there’s little evidence that the SCT had any meaningful impact on the size of Russia’s shadow economy. And if the Russian consumer isn’t being supported by increasing unofficial payments, then the recent trend in spending growth is unsustainable. Forecasters should be wary of counting on the underground economy to support the above ground one.
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