www.worldbank.org.ru

The World Bank, Russia Country Department

Contents:

Introduction

I. Recent Economic Developments
GDP and Industrial Production
Investment and Capacity Utilization
Private Sector Credit
Enterprise Finances
Monetary policy and inflation
Exchange Rate and Balance of Payments
Fiscal policy and the budget
Income, Labor Market Indicators and Poverty

II. The Link Between Real Income and GDP Growth

III. E-Learning in Russia’s Schools
Why e-learning?
How to implement e-learning?

Introduction

With an estimated 7.2 percent growth in the first half of 2003, Russia’s economic performance once again exceeded even the most optimistic expectations. High growth was accompanied by impressive advances in household incomes, industrial production and investment. Yet, this performance once again followed an equally impressive increase in the price of hydrocarbons, Russia’s main export commodity. In the wake of the political events surrounding Iraq, the average price of Russian oil for the first half of the year increased from 18.5 US Dollar per barrel to 23.7, or by 28 percent compared to the same period last year. This raises the question of how much of Russia’s progress is the result of this increase in the prices of oil and gas and, whether this rapidly growing economy is becoming less dependent on oil?
Part I of this report, in an overview of recent economic developments, addresses this question. It first looks at the growth rates of two sub-sectors comprising industrial production in Russia, natural resource industries and manufacturing industries that mostly produce for the domestic market. Comparing a weighted average of the growth of both segments shows that “domestic manufacturing”, while growing by an impressive 6.1 percent has once again been outpaced by the export oriented “natural resource” sectors, that grew by 8.5 percent. By this measure alone, Russia’s dependence on natural resource exports has increased, not diminished.
However, two additional factors need to be taken into consideration. The first is the production of services, which in Russia generates a larger share of GDP than the production of goods, and which continues to grow faster. Second, to generate a reasonable estimate of the contribution of the hydrocarbon sectors to aggregate economic growth requires an assessment of the indirect as well as the direct consequences of changes in oil and gas prices.
Employing the results of a World Bank study, the report provides a range of estimates on the extent to which the change in the oil price affected GDP growth in the first half of 2003. The most plausible estimate implies that three percent of the 7.2 percent growth has been due to the direct and indirect effects of the oil price increase and 4.2 percent to non-oil factors. At current oil prices (and assuming no further changes with respect to non-oil factors), this implies a growth rate of 6 percent for the full year of 2003.
In addition, the report indicates that since the crisis, growth rates over 5 percent have only been achieved in conjunction with an increasing oil price. The goal of doubling GDP in ten years or less can therefore only be achieved if either the oil price continues to rise, or if total factor productivity in Russia’s economy increases significantly.
What does this imply with respect to oil dependency? Overall Russia’s economy has stabilized remarkably, and it continues to show signs of improvement, in particular increasing rates of investment and continued structural change. Looking back in time, the economy is in better shape than at any other time since the beginning of reform. However, growth remains vulnerable. Neither domestic consumption nor domestic investment are yet strong enough to guarantee a self sustained recovery. Looking forward, the desired high growth rates do require unrealistically high prices for oil and gas – or an acceleration of structural reforms.
Part II takes a look at a seeming puzzle. The last few years have seen real disposable household income and real wages outperform GDP growth. Wage receivers therefore seem to have benefited disproportionately from GDP growth, and for some time now economists have wondered how long wage increases that outpaced productivity increases could be sustained. However, wages fell much more than GDP after the crisis and wage growth remained negative for a longer period of time. Viewed over the medium term, higher wage and income growth has been an adjustment to wage and profit shares as they existed before the crisis. One important implication of wage growth falling increasingly in line with productivity growth is that the same economic benefits to wage receivers will require higher GDP growth than in the past.
Finally, part III of this issue of the Russia Economic Report highlights a recent World Bank analysis of the need to integrate modern information and communication technology into Russia’s strategy for education reform.

In the first half of 2003, Russia’s economic performance once again exceeded the most optimistic xpectations. The Ministry of Economic Development and Trade (MEDT) estimated growth for the first six months of this year at 7.2 percent. To some extent this muted the debate on the sustainability of growth. However, Russia’s economy during this period also faced an extremely favorable external environment. The political tension around Iraq provided a lasting boost to hydrocarbon prices, with the price for Russian oil rising from an average of 18.5 US Dollar per barrel in the first half of last year to 23.7 US Dollar over the same period this year. In addition, the massive appreciation of the Euro against the Dollar (supported by domestic cash holders who increasingly entrust their money to banks and thus slow down velocity) limited the real appreciation of the effective exchange rate to 3 percent over the first six months of 2003, and this sheltered the price competitiveness of domestic producers. If one looks at the sources of growth, consumer demand is the biggest component of aggregate demand. It grew by 6.4 percent, a little less than GDP but strong, and perhaps unsurprising, given a background of real disposable household income that allegedly shot up by 15.1 percent, i.e. much faster than GDP. The economy also witnessed a considerable jump in fixed capital investment, which increased by 11.9 percent over the first half of this year (the growth rate of gross capital formation was 14.1 percent). The direct effect of the terms of trade was, at 3.5 percent, relatively minor. In addition, Russia’s net investment position improved significantly, with capital inflows exceeding outflows for the first time since 1999 (by 3 billion USD). All these factors contribute to high output growth. However, the questions of causality and relative importance remain. Increased revenues from natural resource exports can generate multiplier effects on domestic production outside the hydrocarbon sectors even in the short term. But to what extent is the resulting increase in domestic demand self-sustaining, or to what extent are high consumption and, especially, high investment growth driven by higher export demand? To approach an answer one needs to quantify the direct and indirect effects of the current high oil price more precisely.

GDP and Industrial Production

A convenient way to approach the question of oil dependency is to decompose Russia’s GDP growth. Aggregate GDP growth in the first half of this year was sufficiently strong to reverse the tendency toward declining growth rates that dominated the official GDP figures since mid 2000. This also holds for the sub-sectors that comprise industrial production (table 1). Previous reports have pointed out how the service sector started to dominate aggregate production and, even according to official statistics, how the production of services grew faster than the production of goods last year. This has not changed.
According to preliminary estimates, industrial production grew by 6.8 percent in January-June 2003, compared to 3.2 percent a year ago. 12 out of 15 industries surveyed by Goskomstat reported positive growth for the period. These high growth rates have noticeably shifted upward the 12-month moving average growth in industry presented in figure 1. However, decomposing industrial production reveals that this growth is still driven mostly by natural resource exports.
Table 1 provides the decomposition into two sub-sectors, namely extractive and export oriented industries, i.e. natural resources and natural resource processing, and industries primarily producing for the domestic market, i.e. “traditional” manufacturing. Over the first six months of this year, the weighted average growth rate of the resource sectors accelerated from 5.5 percent to 8.5 percent year on year. Growth in the domestic-oriented sector reversed the negative trend observed from 1999 to 2002, but this increase - to an average of 6.1 percent, compared to 2.5 percent last year -- still was below growth in the resource sectors. By sub-sector, fuel and energy and ferrous metallurgy reported the highest growth rates, of 10 and 9.5 percent respectively, while the manufacturing sector also experienced noticeable improvements, with machine building growing the fastest, at 7.6 percent. Electricity production grew by 7.1 percent, in line with overall growth.

Table 1: Growth Rates in Export and Domestic Oriented Industries

These are positive trends, but reported growth across the manufacturing sectors has been uneven. On the one hand, not all industries reported robust growth. Among those that did not are sectors that mostly target the domestic market and have limited export capacity, such as light industry or, unexpectedly, the food industry which grew “only” 4.3 percent compared to an average of 7.4 percent 1999 through 2002, and which continues to decelerate. If measured correctly – a big “if”, given the recent controversy about and corrections of Goskomstat data  - this would be an indication that relatively strong growth in consumer demand fueled by high growth in real incomes did not seamlessly translate into adequate growth in domestic consumer good industries. A large fraction of additional consumer demand goes to imported goods (imports increased by 22 percent over the first half of last year) as a few sectors continue to lose the competitive advantage they gained through the 1998 devaluation. (An income effect – increased demand for better quality as household incomes rise – works in the same direction).
On the other hand, a number of manufacturing sectors reported unexpectedly high growth rates, in particular electricity, machine building and the chemical industry. Partially, this is explained by exports, facilitated by the depreciation of the Ruble against the Euro. In fact, total machinery exports increased by 7.8 percent (January through May), compared to a 1 percent rise during the same period last year; export of electricity increased by 36 percent against a decline of 25.4 percent last year; export of selected chemical products increased in a range of 30 to 40 percent against either a decline or an unchanged situation last year. The jump in fixed capital investment partially translated into an increased supply of machines and equipment. However, with more than 70 percent of registered fixed capital investment going into either the fuel and energy sector (26.7 percent) or dependent on the public purse, there are large spillovers from the energy sectors and the budget, and hence ultimately from the price for hydrocarbons to the rest of the economy.
Decomposing industrial production growth suggests that the direct impact of natural resource extraction on private sector growth outside the service sector has increased and not diminished. At the same time, export revenues also continued to contribute to aggregate service sector growth because government services are largely a function of oil revenues, and because the expansion of market services is fostered by real exchange rate appreciation, which also is a function of export revenues.
Yet, the contribution of the natural resource sector to GDP growth is only 18.9 percent, with oil and gas accounting for 10.3 percent - not significantly different from last year. Around 85 percent of all exports are natural resources, the share of oil and gas is 60 percent. To a large extent, the contribution of revenues from extractive activities to GDP and GDP growth therefore is indirect. To determine the total contribution of the hydrocarbon sector to aggregate economic growth requires assignment of numerical values to these indirect effects on consumption and investment. With a share of over 70 percent in aggregate demand, consumption demand will for the foreseeable future be one of the key determinants of growth. The share of investment is much smaller (14.5 percent), but its rate of growth over the first half of 2003 has greatly outperformed consumption growth. With 34 percent of aggregate investment into natural resources, and 27 percent into the fuel and energy sector, there have to be sizeable spillover effects of investment outside these sectors, e.g. to service the machinery and equipment needs in the hydrocarbon industries. But how big is the indirect impact of oil and gas on recent investment and consumption growth? Was a large part of the 2003 increase in demand driven by high oil prices, or is the role of hydrocarbon exports becoming more limited?
Table 2 contains a simple decomposition of GDP growth rates into two components, which aims at isolating the relative impact of oil and non-oil factors on aggregate growth in the first half of 2003. The oil price effect captures the direct and indirect contribution of oil price changes on the growth rate; the residual captures the contribution of non-oil price factors.
The oil price effect is calculated using the elasticity of GDP growth rate with respect to changes in the average price for Russian oil. Table 2 contains three elasticities to capture the effect of oil price changes on GDP growth. The middle estimate of 0.07 (implying that an increase of one percent in the average price of oil adds 0.07 percent to GDP growth) is derived from calculations in a forthcoming World Bank study that, going back to 1994, attempts to model the relationship between the real exchange rate and GDP. In the table this elasticity is complemented by two other scenarios, depicting elasticities of 0.05 and 0.1 respectively. These are included here just so as to generate a broader range of estimates.
For these calculations, we assume a three month lag between the contract and the actual impact of oil receipts on expenditure. The oil price effect on GDP growth in the first half of 2003 therefore was calculated using the percentage change of the average Ural price during the period October 2001 through March 2002 (17 US Dollar per barrel) to the average price from October 2002 through Mar 2003 (24.3 US Dollar per barrel). The percentage change for this period is 43.2 percent.
With a percentage change of 43.2 percent and an elasticity of 0.07 percent, the implied increase in the growth rate of GDP in the first half of 2003 is 3 percent. Using the plausible range of estimates in table 2, the effect of increased oil prices on growth would be between 2.2 and 4.3 percent. The conclusion from these estimates is that GDP growth for the first half of this year (in fact reported at 7.2 percent) excluding the impact of the quite dramatic oil price increase since late 2002 would have been somewhere in the range of 2.9 to 5 percent, and in our best estimate, it would have been around 4.2 percent.

Table 2: Decomposition of GDP growth rate in 2003.

Source: Goskomstat, Staff calculation

In general, repeating the exercise over time shows what one would expect, the higher the change in the oil price, the lower the contribution of non-oil activities to GDP growth. This works both ways: just as the massive oil price increase in 2000 resulted in a large contribution (of 5.9 percent) of the oil price to reported GDP growth in 2000 (of 10 percent), small declines in the average oil price over the next two years contributed negatively. The effect of a changing oil price diminished GDP growth in 2001 by minus 0.1 percent (growth was 5 instead of 5.1 percent), and in 2002 by minus 0.9 percent (GDP growth was 4.3 percent instead of the 5.2 percent it would have been had the oil price remained as high as in the previous year). One of the important consequences of this observable interaction has been that, thus far, growth rates of five percent or higher have been realized in Russia only at times when the oil price has significantly increased.
Obviously, the counterfactual will always be impossible to prove. However, these calculations do not include natural resource exports other than oil and gas (the price of which tends to move cyclically with the price of hydrocarbons). They are therefore unlikely to overstate the indirect contribution of natural resource exports to Russia’s growth.
Table 2 also shows the impact of these calculations on the growth rate for the reminder of the year. Assuming that oil prices remain at current levels (at 27 US Dollar per barrel, which represents an increase over last year’s price of approximately 12 percent), and that non-oil growth determinants remain constant during the rest of the year, leads to a range of growth forecasts between 5.6 and 6.4 percent for the total of the year 2003, with 6 percent the value which in our estimate appears most likely. (Accident or not, this is almost equal to the revised annual growth forecast of MODT and it comes close to the latest consensus forecast of the Development Center which was 5.8 percent). Anything significantly higher than this value would require the oil price to rise even further than the current 27 US Dollar per barrel.
Compared to neighboring countries, this means that despite the progress that has been made in particular with respect to investment, at this point there remains a high degree of skepticism as to Russia’s capacity to sustain high growth rates without extended support from hydrocarbon prices. The economy is on the right track, but the recovery is not yet selfsustaining.

To get a clearer view of the extent to which the economy is on the right track, it helps to look at investment. The unexpectedly high growth rates in industrial production in the first half of 2003 have been accompanied by a jump in the growth of registered fixed capital investment as well as by gross capital formation. According to preliminary Goskomstat estimates (figure 3), fixed investment increased by almost 12 percent during the first half of 2003 (compared to 2.5 percent during the same period last year), growing by 14.7 percent year on year in May alone (compared to 3.5 percent in May 2002); gross capital formation increased by 14.5 percent.
To be sure, part of this hike is a reflection of exceptionally low growth rates in investment during the first quarter of 2002, which in turn must partially be attributed to a change in tax laws. However, the acceleration of fixed investment growth in March and April 2003 suggests that the economy is experiencing a substantial increase in investment demand. The bulk of investment continues to be attracted by fuel and energy (which attracts 27 percent in the first quarter, up from 25 percent one year ago, although the sector’s contribution to GDP is only 7.4 percent), as well as by sectors directly or indirectly dependent on public funds (e.g. transport, including pipelines, with 15 percent, or housing and utilities with 14.6 percent). The electricity sector (which comprises 6.8 percent of GDP) attracted 4.7 percent of all investment in the first quarter of 2003, the food sector (5.5 percent of GDP) 4.6 percent and machine building (7.6 percent of GDP) 3 percent.
Whether these high rates of investment can be sustained, in particular outside the natural resource sectors, will determine the future. For four years after the crisis, Russia increased production by increasing capacity utilization rates, as the economy recovered from the substantial decline in output during the nineties and in 1998. By 2002 this potential for ratcheting up utilization rates seemed to have been exhausted – yet full capacity utilization in many sectors did not translate into high rates of investment (outside oil and selected resource sectors). This seems to have changed in the first half of 2003 – and if it is a lasting reversal, the ignition of investment will in retrospect be seen as the most important development of the year 2003.

Table 3: Investment and Capacity Utilization, % rates of change

* In January and February 2002, related to the introduction of new corporate profit tax regulation on January 1, enterprises tended to underreport (and had previously accelerated expenditures for) fixed capital investment. The factual underreporting during that period leads to an overestimation of the nominal growth rate of investment during the first quarter of 2003. See RER5 for a detailed explanation.

At the time of this writing, there was only one time series on capacity utilization rates available for 2003. According to that series from the Center for Economic Analysis, increased fixed capital investment and high export demand translated into an additional increase in utilization rates of 4.5 percent (table 3). Utilization levels are notoriously hard to estimate in Russia, because enterprises tend to report nominal capacity which often includes economically or physically obsolete plants, machines and equipment, so that effective utilization levels are likely to be substantially higher than nominal ones.
Nevertheless, it is instructive to break down reported utilization levels by sector. It turns out that utilization rates are highest in those sectors that have attracted the bulk of investment in recent years, i.e. selected natural resource sectors: Utilization levels range from 67 percent in non-ferrous metals to 70 percent in ferrous metals, 71 percent in wood processing, to 80 percent in fuel and energy. On the other hand, light industry (46 percent), machine building (47 percent) and food processing (50 percent) have low utilization rates.
The latter are the sectors that attracted a low share of total investment in the past. Even allowing for the fact that “virtual” capacity (which may be still on the books but actually is obsolete and cannot be used) is reported predominantly in the sectors that had little investment in the past, the picture that emerges is one in which those sectors that had received most upgrades and repairs - and presumably also have added new capacity - have higher degrees of capacity utilization. These numbers do make sense – but they show an economy where investment still is attracted and fresh capacity created mostly in the natural resource sectors.

According to figures published by the Central Bank, credits to the private sector increased to 2271 billion rubles (74 billion US Dollars) by the end of May 2003, up from 2029 billion rubles at the end of 2002. In real terms, this reversed the 7 percent decline of net credit to the private sector observed over the first 5 months of last year with an increase of 5.6 percent.
The maturity structure of the stock of outstanding credits remains almost unchanged, with the share of net long and medium-term credits (with a maturity of more than one year) increasing slightly, from 27.6 percent in the first five months of 2002 to 29.4 percent in 2003. The upward trend in consumer credits continues this year, as the share of credits to consumers as a percent of total credit increased to 8.7 percent in May (figure 2). If the reflux of Russian flight capital from abroad continues, and the liquidity position of Moscow based banks continues to improve, this tendency is likely to accelerate. It is supported not only by an increased supply of liquidity, but also by increased demand as new financial products take hold (such as credit card use, or a better availability of mortgage finance). Hence, interest rates can be expected to decline for consumer finance.
Despite improvements overall in medium and long-term lending to the real sector, domestic bank credit in Russia still plays an insignificant role in financing enterprise capital formation. While equity markets in an environment with fragile corporate governance are unlikely to take up much of the slack, enterprises – many on the back of improved sovereign credit ratings – have started to supplement on a large scale the lack of domestic bank credit by raising funds on the bond markets, both domestically and abroad.
Table 4 shows how Russian companies since 1999 have increasingly raised funds on the domestic market. From only 17 billion Rubles at the end of 1999, the stock of outstanding corporate bonds has grown to 24 billion Rubles by May of this year. As an indicator of the growing relative importance of the bond market in total corporate finance, the ratio of bonds outstanding to total bank credits to enterprises is now estimated at 6.9 percent (May 2003), up from 6.8 percent at end-2002 and 5.6 percent at end of 2001.

Table 4: Development of the Corporate Bond Market

According to the official statistics, the surge in economic growth over the first half of this year has been accompanied by a decidedly mixed financial performance on the enterprise level. While reported profitability, (calculated as revenues over cost) increased to a cumulative 24.5 percent from January through April (compared to 17.4 percent in 2002), official statistics continue to record a very high share of loss making enterprises, which they report to have increased from 44.3 percent in April 2002 to 45 percent in April 2003However, other indicators point in the opposite direction and suggest that the overall financial position of the enterprise sector as well as payment discipline actually improved. Despite the increase in the number of loss-making companies, the stock of overdue payables continued to fall at rates that at the beginning of 2003 exceeded those observed in 2002. By April, arrears had fallen by 84.5 billion rubles or 6 percent, relative to December 2002 (figure 5).
As budget constraints for the enterprise sector continue to harden, the improved financial position of the enterprise sector, together with better monetization of the economy as a whole, resulted in further reductions in the level of non-cash transactions. The average share of non-cash settlements in total sales fell to 15.2 percent over the period January through May 2003, compared to 18 percent during 2002 and 22.7 percent during 2001 (figure 4). The reported share of non-cash settlements in May – 14.5 percent - is the lowest since Goskomstat began to reporting this statistic. An improved financial position, better availability of bank credit, and improved liquidity overall have enabled enterprises to continue eliminating non-cash transactions – somewhat contradicting official estimates of the increasing share of loss making enterprises.

As the election approaches, inflation has re-emerged as a serious issue in public policy. While inflationary expectations continue to diminish and while effective government control over the price setting of the energy and transport monopolists has been restored, inflation rates over the first half of the year have been driven by Central Bank (CBR) policies and fueled by the need to sterilize foreign currency inflows, as well as by a lack of instruments on part of the CBR. Inflation for the first six months 2003 reached 7.9 percent, compared to 9 percent over the same period of 2002.
Sterilization efforts were supported by the fact that the population continued to transfer cash holdings from “under the mattress” into banks, thus reducing the velocity of circulation. From January through June of 2003, the money supply (M2) increased by almost 23 percent – considerably faster than consumer or producer price indices. However, declining velocity of money circulation has contributed to price stability. The relatively high M2 growth improved further the monetization of the economy, bringing the ratio of M2 to GDP to 18.5 percent, up from 16.1 percent in 2002 (figure 10).

Figure 10: Ratio of M2 to GDP and Inflation, percent

Exchange Rate and Balance of Payments

The exchange rate of the Ruble to the Euro is determined as a cross rate between two exchange rates – that of the Ruble to the US Dollar, which is determined on Russia’s financial markets, and the Euro-US Dollar rate for which Russia is a price taker. Under these circumstances, fluctuations of Russia’s real effective exchange rate (REER) are currently driven by the Dollar/Euro exchange rate, which has been more volatile than the Ruble/Dollar rate.
The sharp appreciation of the Euro against the Dollar in late 2002 and early 2003 caused the nominal Ruble/Euro exchange rate to depreciate by 4.3 percent over the first half of this year. During the same period, the Ruble appreciated 4.5 percent against the dollar in nominal terms. These countervailing mechanics ensured that real effective exchange rate appreciation remained modest.
The implications are favorable for the trade balance and also for inflation, since with less hard currency inflows, pressures to sterilize and therefore inflationary pressures are reduced.. Russian exports are mostly denominated in US Dollars, while many of Russia’s imports come from the Euro zone. While the current configuration is helpful to price competition of Russia’s exporters, imports are becoming more expensive. However, this affects not only consumption items but also imports of machinery and equipment.
While the value of Russian exports is significantly affected by high oil prices, the balance between imports and exports shifted to reflect these pressures (figure 8). Average monthly exports amounted to 10.1 billion US Dollar in the first 5 months of 2003, compared to 7.9 billion in 2002. Average monthly imports also increased, but not as much, namely to 5.3 billion US Dollar from USD 4.4 for the same period in 2002. This uneven development generated a more than 30 percent increase in the trade surplus (table 5).
The higher than expected surplus in the trade balances further reinforced Russia’s balance of payment position. The CBR continued to accumulate substantial foreign currency reserves which by the end of July had increased to an all time high of 64.5 billion US Dollar, despite large debt repayments.
Meanwhile on the capital account, the reversal of capital outflows has become more and more visible. Preliminary estimates based on the CBR’s Balance of Payment statistics indicate that net capital outflows remain at the relatively low level of last year. In the first quarter of 2003, they amounted to approximately 3 billion US Dollar. Following increased inflows toward the end of 2002, Russia’s net foreign investment position became positive for the first time since 1999. In the first half of 2003, total foreign investment inflows exceeded investment outflows by 3 billion US Dollar.
The composition of foreign investment in Russia remains characterized by increasing components of portfolio and “other” investment (mostly credits), while FDI remains miniscule without much change over the first half of 2003. According to Goskomstat, FDI accounts for only 20 percent of total investment inflows (22 percent in 2002), while the socalled other investments dominate total inflows (79 percent of the total in the first half of this year, compared to 75 percent in 2002). By countries of origin, these inflows continue to originate mostly from off shore centers such as Cyprus, the UK channel islands, or the Netherlands’ Antilles. In other words, to a very large extent these funds represent Russian money coming home.

Fiscal policy and the budget

Higher prices and the growing share of hydrocarbons in the economy have ensured a strong effect on tax revenues. However, this has been amplified by recent changes in the tax regime, especially with the introduction of a tax on the extraction of oil and gas, which is indexed to the price of Urals on foreign commodity exchanges. A variation of the average annual oil price by 1 US Dollar per barrel is estimated to change budget revenues by 0.3 percent of GDP, and the increased oil prices in anticipation of the war in Iraq have positively affected fiscal balances. According to preliminary numbers from the Ministry of Finance, the primary and the overall federal budget surplus on a cash basis during the first six months of 2003 amounted to 4.9 and 2.9 percent of GDP, respectively, and thus significantly exceeded the target of the 2003 Budget Law.
In order to protect budgetary expenditure targets and help manage the adverse effects of oil revenues on the real exchange rate, the government has decided to convert the existing financial reserve into a formal stabilization fund next year. Three sources of revenue are expected to feed the stabilization fund. The first is a share of the oil (and probably gas) export duties, which is calculated based on the difference between the market price for Ural and a reference price, to be determined as the long term average price. The second is a share of the tax revenues from oil extraction, calculated again as a function of the excess of market over reference price. The third source would be any eventual fiscal surplus exceeding the amount specified in the Budget Law.
Conversely, world oil prices falling below the reference point or budget revenues short of the targeted amount can be offset from the stabilization fund. The budget for 2004 so far assumes a Ural price of 22 US Dollar per barrel, well above the historic average of about 18 US Dollar per barrel, but well below current prices.

In Russia, where a large proportion of poverty is “shallow” (i.e. a large share of those living below the official poverty line have incomes close to that threshold), economic growth has an immediately visible impact on the poor, and the year 2003 has been no exception. However, although rapid growth led to an overall improvement in income, this has not necessarily translated to broader social indicators, such as life expectancy or unemployment.
Unemployment continued to increase, according to revised unemployment statistics for 2002 and the first quarter of 2003. Following the revision, Goskomstat reports an increase in the rate of unemployment (ILO definition) by the end of 2002 to 8.6 percent, one and a half percentage point higher than the 7.1 percent reported earlier. In the first quarter of 2003, the average level of unemployment increased to 9.1 percent (compared to 8.4 percent a year earlier), and by the end of June it stood at 8.6 percent-- more than one percentage point higher than in June 2002.
However, income data as well as poverty data suggest that much of this rise in unemployment is the result of efficiency-enhancing economic restructuring rather than value-destructing economic decline. Despite the negative tendency for employment, reported poverty data continue to show improvement. The share of the population living below the subsistence level (for the period under consideration estimated at 2047 Rubles or 66.4 US Dollars per month) fell from 31.5 percent in the first quarter of 2002 to 26.1 percent in the first quarter of 2003, and continues to decline further to 24.6% for the first half of 2003.

II. The Link Between Real Income and GDP Growth

For the fourth year in a row, real disposable household income grew faster than GDP during the first half of 2003. According to preliminary data, real disposable income increased 15.1 percent from January through June, compared to 10.1 percent over the same period a year earlier. Real wages increased by 9.7 percent over this period, following a 18.2 percent increase in 2002. Partially because of the sharp real appreciation of the ruble against the dollar (11.6 percent January through June), the average monthly dollar wage rose to USD 184.2 in June 2003 (figure 9), which is 30 percent higher than it was in June 2002.
This means that real disposable household income has increased by a cumulative 58.5 percent since its low in 1999, while GDP over the same period grew only by 28.7 percent. At first glance, this would seem to imply a puzzlingly large redistribution from income categories not covered as “household incomes” to that category. But how likely is this? The following section addresses this puzzle.

Goskomstat’s methodology for calculating real disposable income appears to leave itself vulnerable to statistical mistakes and this is how most people have so far explained the excess of real income over GDP growth. The category “household income” is calculated using expenditure surveys to estimate household income which, if GDP and wage data are underreported (for example, because of non-reported activities in the gray economy), would make income data collected on an expenditure basis appear larger than the income data collected from enterprise or governmental reporting. However, this could explain systematic differences in growth rates only if there were good reasons for the “reporting gap” to increase year after year and there appear to be no such reasons.
A number of Russian researchers have pointed out another flaw of the methodology, namely that it entails double counting. The category real disposable household income is based on gross expenditures of the population, including gross foreign currency purchases. This means that every time someone buys US Dollars (with Rubles received in this or any previous period), expenditures and therefore reported household incomes increase, whereas the sale of US Dollars back into rubles is ignored (and shows up only to the extent that the Ruble proceeds are spent again). However, while ignoring other foreign currency transactions by households may lead to significant distortions, it is not clear that they are large and lop-sided enough to explain the observed systematic discrepancy between the growth rates of GDP and of household income. In addition, cash US Dollar holdings (which introduce an upward bias into the current measurement of expenditures) have been decreasing over time. It seems therefore also doubtful that this methodological flaw accounts for an explanation of the phenomenon.
Figure 11 suggests that the explanation may lie elsewhere. It may have to do more with the flexibility of Russia’s wages and salaries in response to both the adjustment costs of the 1998 crisis as well as the subsequent recovery.
The first observation is that the pattern does not change if the income data discussed above are replaced with real wage data. Real wage development, while generally moving in the same direction, is much more pronounced than GDP growth and also markedly more pronounced than income growth. Even if reported wage data have their own problems, this indicates that the alleged behavior of real household income is not a statistical fluke, but part of a pattern which goes back at least to the 1998 crash.
From figure 11, it becomes obvious who bore the brunt of the adjustment costs of the 1998 crisis. Following the crisis, real wages (just as household income) fell much further and for a more prolonged period than GDP, indicating a redistribution of incomes between recorded wages and profits. A look at published wage and profit shares confirms that the wage share declined after the crisis, only to recover later on (see RER 5). Ultimately, the 1998 crisis – not different from any similar crisis -- implied the need to adjust wages and profits to aggregate output. Something had to give, as the economy produced less than what was claimed by the sum of economic agents. In the first instance, in Russia’s economy (and again, relying on official data), it was the wage and salary receivers who bit the bullet.
This rapid decline in real wages was caused by an inflationary spike immediately after the crisis; and, in addition and as time progressed, by the need for the enterprise sector to engage in serious cost cutting, as enterprise budget constraints hardened and direct and indirect subsidies dried up after the financial collapse. It may also be worth remembering that the nonpayment crisis of late 1998 and 1999 greatly contributed to the costs born by wage and transfer income receivers, such as pensioners. This effect is not even covered by the wage data in figure 11.

Figure 11: Comparative Growth Dynamics

However, as utilization rates increased and the economy started to recover, productivity shot up and wages were quick to rise from low levels, in particular in locations with migration gains or where a shortage of skilled labor appeared. From the year 2000 onward, real wage growth thus exceeded GDP growth. Clearly, the episode demonstrates a flexibility of Russia’s labor markets that exceeds often claimed impressions and confirms the observation that relocations and spatial adjustments, as well as sectoral adjustments in Russia’s economy are proceeding at a faster pace than often imagined.
There are two interesting conclusions to these observations from an economic perspective. The first concerns the extent to which the short-term ability of the labor market to adapt coincides with stable long-term relationships: while real wage growth in the short term (in particular the last few years) may have greatly overshot labor productivity growth, and while labor remuneration rates immediately after the crisis dropped greatly below labor’s contribution to Russia’s gross domestic product, in the long term the relationship between real wage, labor productivity and GDP growth is remarkably well aligned. Cumulative GDP growth for the period from 1996 through 2003 amounted to 31.5 percent, while real wages grew by 30.2 percent, which leaves the wage share at 47.1 percent in 2003, not far from 51 percent, the value seven years earlier. In this sense, post crisis developments entailed strong corrective mechanisms.
Second, the data on real wage growth and GDP growth appear to be converging. This is as it should be. In a hypothetical and fully balanced economy, all these variables would grow at the same rate. In Russia, a period of relative stability causes the previous discrepancies to diminish. However, it is worthwhile remembering that this process of convergence does not imply anything about the long-term growth rates at which convergence eventually is approached.
What the process does imply, however, is that from an economic perspective, it is correct to tie the fight against poverty to rapid GDP growth, as the President has done. In the future (and if there are no major distortions), income growth will be increasingly aligned with GDP growth. It will become increasingly impossible to see real household incomes grow faster than GDP. And if income growth of the magnitude experienced over the past few years is considered necessary to improve social indicators and living conditions, this will require boosting GDP growth even more than before - which in turn is possible only to the extent that the overall productivity of Russia’s economy increases.

III. E-Learning in Russia’s Schools

There can be little doubt that the transition to a new economic system so far has brought little tangible benefit to Russia’s education system. It may be true that in many ways this system was ill-equipped to provide the content and the skill mix required by the new environment. However, disorganization and underfunding have certainly not made it any easier to adapt. Lack of resources and a brain drain have hurt Russia’s institutions of higher education. Low salaries, crumbling infrastructure and often irrelevant curricula plague its primary and secondary systems, and vocational training suffers from the difficulty of adapting to new knowledge in an environment that is badly endowed and not conducive to innovation.
In this situation, the authorities have launched a major effort to improve the employment of information and communication technologies (ICT) to foster reform of Russia’s education system, and to help it catch up with standard practices in other countries. In fact, a generous part of the scarce available funds of the education budget have been earmarked for investment into this area. The government’s proposals to this effect are build around a federal program (“E-Russia”) that aims to increase the diffusion of modern electronic communication technology in general, and an “E-Education” program that targets specifically the application of these technologies at all levels of the education system. The following summarizes a recently published World Bank study that reviews this task and discusses policy options and recommendations designed to support the implementation of “ELearning” in Russian schools.

Russia today is investing a significant part of its education budget into employing information and communication technologies (ICT) in the future, targeting general schools as well as vocational and higher education. However, it is not clear from the outset that this is the most promising way to upgrade the education system. In the international discussion of education reform and the upgrading of national education systems, three issues are commonly distinguished that need to be addressed to establish an education system suited to meet the challenges of the modern world. The reason to emphasize the introduction of ICT in education, and to make it one of the priorities of reforming any education system, would then have to be evaluated against the background of addressing these major tasks in Russia’s specific situation.
The first of the internationally recognized challenges is to grant equal access to education of good quality. The second is to ensure the introduction of new methods of teaching and learning, adequate to the modern information age. The third challenge is to ensure the development of ICT skills among the students at the different levels of a national education system.
It is easy to see that the development and increasing relevance of ICT in the economy and society at large may accentuate the first challenge and make it even more difficult to achieve equal access to good education. Russia’s previously quite equitable education system has already lost much of its ability to provide access for all students to a high level of education and vocational training. The growing importance of ICT has the potential to increase these differences.
To the extent that ITC technologies are not spread so as to guarantee access to every student and pupil, its emergence will cause a “digital divide” to develop – between those who have access to modern computers and networks, and hence communication technologies, and those who do not. In the case of Russia, this divide is already visible. It grows fastest along two fault lines, one that separates students from rural and urban areas, and one that separates students from richer and poorer families. The report contains detailed data on Russia’s ICT infrastructure, including two regional case studies, that show the extent to which the digital divide in access to the new technologies has grown, while these technologies themselves have gained in importance. It is hard to see how this could be rectified, except by guaranteeing better access to ICT.
The second challenge is to introduce new ways of teaching and learning, designed to produce learning outcomes that meet the requirements of the modern information age and the modern, flexible economy. This problem of redesigning educational form and content goes to the heart of Russia’s current educational reform agenda. It relates, in particular, to the need for an encompassing overhaul of educational curricula and of diversifying them; to the need to adopt changes in teaching methodology toward a more student centered practice to help develop the capacity to adjust quickly and to upgrade skills continuously; and to the need for more flexible organizational forms at the different levels of the education system.
Equal access to education may be the most important and immediate of the three challenges, but changing the quality of teaching and learning certainly will be the most difficult. It seems fairly obvious that the use of modern information and communication technology has the potential to be of great assistance in this undertaking. In fact, it is difficult to see how this goal could be achieved in a timely manner without ICT support. Yet, as the report argues, the mere installation of networks and computers will not suffice. To improve the quality of education requires a sustained effort at changing the curriculum and retraining those who do the teaching, and for this to be successful it will be useful to draw on the experience gained elsewhere.
The third task, to ensure the development of ICT related skills so as to endow students with the tools to be productive in an ICT-based economy provides a straightforward justification for introducing ICT into schools and vocational institutions. Ironically, the Soviet Union was among the pioneers in introducing early computer access in schools, although with a very strong emphasis on programming (rather than on the communication components of today’s technologies). At the beginning of the nineties, up to 28 percent of schools were equipped with computers, usually of Soviet make. However, by now most of this early advantage has been lost. Access to computers generally is scattered and biased. General education and vocational institutions in particular have been falling behind ICT access in higher education. In many cases, still impressive numbers hide outdated equipment and lack of access to communication capability.
ICT related skills can be understood in two ways, as universal computer literacy or as advanced technological skills. Although courses in the latter are needed to create a skilled IT workforce, the report argues they should not be mandatory for all students: Basic universal computer competence should be sufficient.
Although there is no reliable data on ICT literacy among Russian school students, the latest results from the Program for International Student Assessment (PISA) are discouraging. They show reading skills and simple information processing skills declining. On average, Russian children feel less comfortable with computers and less confident in using them than their counterparts in OECD countries. Until this situation is addressed, it is likely to restrict computer literacy in Russia.

Of course, the three goals and the means to achieve them are interconnected. To this end, the integration of any ITC related program into the general strategy of education reform is necessary. The three central points provide a rational and convenient framework, but at this moment, they are not sufficiently integrated in Russia’s e-education program, and they don’t play a vital role in guiding related policy papers. Without integrating the use of new technologies into the overall education strategy, it will become more difficult to ensure that resources on ICT are spent effectively.
Russia's huge landmass, thinly spread population, lack of available finances, and regional diversity already complicate installing effective connectivity and digital networks. But there are also education-related hurdles to overcome. Currently, the development of a strategy for integrating ITC in education suffers from a concentration on inputs to measure progress (such as student-to-computer ratios and bandwidth), rather than a focus on the use of educational ICT resources and learning outcomes. Serious coordination problems, a lack of reliable statistics, and inadequate regulatory frameworks also need early attention. Of all these barriers, weak program coordination in the face of the multiple institutions and interests involved and a certain lack of vision, i.e. the traditional tendency of officials to focus on technological inputs rather educational outcomes, are the two most difficult obstacles.
The report details indicators to measure the degree of integration of ICT into the education system. The most important ones measure the availability of equipment and connectivity to schools, the degree to which teaching capacity has been developed to employ the new technologies, and the degree to which ICT already influences curricula and learning.
Having established the lag between Russia and other economies by using these indicators leaves two ways to “catch up”: Russia could use these indicators to establish a benchmark, and then establish milestones – i.e. it would simply copy international experience in trying to catch up. Given the current lack of resources, this entails the serious risk of failing to proceed fast enough and to diminish the gap substantially. Alternatively, if Russia could identify a separate comparative advantage, it could build on its own strengths, i.e. follow a different path in catching up with these same key objectives.
But are there comparative advantages that could be deployed to catch up, i.e. to allow the accelerated implementation of organizational and technological solutions that are already employed elsewhere? The basic answer is that Russia does have a number of specific educational advantages (compared to other countries in the same income bracket), and that these could be harnessed by intensifying the use of non traditional resources.
Among Russia’s comparative educational advantages are high educational demands from its people; high technological and engineering standards; good quality basic training of teachers; a high capacity for training teachers and for developing new teaching resources in the regions. And non-traditional resources to foster ICT technologies could include a large one time initial investment to improve the basic infrastructure, and then establishment of an institutional infrastructure that creates initiatives for the private sector, students and the professional community to follow up with actually utilizing these technologies. In particular the following steps would help in freeing up Russia’s potential:

(1) Upfront investment: A well targeted upfront investment into digital education resources and network support seems necessary to catalyze further expansion and updating, including in local and regional networks where broadband access to the internet is not available. 
(2) Improving access: Ensuring common access stations for telecommunications and education resources through a system of inter-school resource centers could help where resources are inadequate to provide such access in each particular school. Free circulation of software and education resources developed by budget resources can support the diffusion of new technologies.
(3) Encouragement of “bottom up” activities: This includes encouraging private sector cooperation, the participation of school’s boards of trustees in equipment acquisition, and the treatment of computer maintenance and upgrading as a regular expense. Supporting the selfeducation of students in information technologies by voluntary, open certification and methodological support will further accelerate diffusion of the new technologies.
(4) Revamp training: Human resource training and general technological and pedagogical standards need to be redefined. Given the significant amount of computer equipment recently made available to teachers, their training on the use of ICT should be a priority. The selfeducation of teachers can be supported by voluntary certification and methodological assistance, and the leasing of computers for personal use.