In the wake of Russia’s assault on neighboring Georgia, much has been made of Europe’s dependence on the Kremlin’s vast energy reserves. Less talked about: Russia’s dependence on Europe for nearly everything else.
In the first quarter of this year, Russian imports increased by a whopping 42%. Europe – especially Germany, which has misgivings about its heavy reliance on Russian exports of oil and gas-eagerly embraced the opportunity to satisfy Russia’s hunger for capital goods. In 2007, Germany’s exports to Russia-machinery, vehicles, chemical products, electronic products and food products-grew by roughly 25%, or three times faster than overall German exports.
The relentless rise of commodities prices during the past decade flooded the Russian economy with cash and sparked a surge in demand for everything from fresh fruit to fast cars. The result was double-digit inflation, acute labor shortages, staggering wage increases and the full gamut of textbook economic overheating indicators.
“All these signs are present in Russia today,” said the most recent issue of the World Bank’s Russian Economic Report. “The current account surplus from high oil prices masks the rapid growth of imports and the deepening of the non-oil current account deficit.”
Russia is simply too small to absorb the swell of oil and gas revenues it has received in recent years. Labor shortages would increase real wages, which in turn would increase prices. In the first four months of 2008, the average monthly wage rose by 40% over the same period the previous year, according to the World Bank. Food prices in Russia have risen rapidly in the past two years and there is no end in sight.
Automotive sales tell the tale. Since 2000, Russia has become the second largest export market for European cars. Unlike other trade relationships, the trade in cars between the European Union and Russia is totally lopsided. For example, the U.S. sells more cars in Europe than vice versa. On the other hand, Russia buys European cars, but Europe doesn’t buy Russian cars.
In the first six months of 2008, car sales in Russia grew by 41%, making Russia’s automotive market larger than any other in Europe, according to a survey by PriceWaterhouseCoopers. Meanwhile, Germany’s exports to Russia rose by nearly 25% to 15.8 billion euros in the first half of 2008, the largest increase among Germany’s major trading partners. Nearly 5,000 German companies have a presence in Russia and several of them, such as car manufacturer Volkswagen, chemicals group BASF, airline Lufthansa and travel group TUI have made substantial investments in Russia. Last week, Volkswagen said it had plans to expand production at one of its plants in Russia to meet the roaring demand.
Demographics will accelerate the trend. After the Soviet Union collapsed in 1990, Russia and former Soviet satellite states in Eastern Europe slipped into a state of decline that has yet to hit bottom. Russians stopped having children and started dying younger and younger. In fact, Russia is one of the few nations where male life expectancy fell between 1960 and 2000.
Today, heart disease, traffic accidents and alcoholism kill so many Russians that the male life expectancy is under the age of 60. In the past 15 years, Russia’s population has plunged by more than 6 million. If current trends continue, those losses could increase by another 18 million people by 2025. In other words, Russia would slip from the sixth-most populous country in the world to the 17th.
Meanwhile, Russia’s workforce is shrinking even faster than its overall population. In recent years, more than 700,000 working-age people have left the workforce each year. By 2010, the workforce is likely to shrink by almost 9 million, from the present 74.5 million to the reduced figure of 65.5 million, according to data from the Russian Health and Social Development Ministry.
The trade relationship between the E.U. and Ukraine over the last decade illustrates the potential export market for European goods in Russia.
Since 2000, Europe’s trade in goods with Ukraine has more than tripled in value. Europe’s exports to Ukraine have climbed nearly twice as fast as imports, bringing Europe’s trade surplus with Ukraine from 0.6 billion euros in 2000 to 10.0 billon in 2007.
Ukraine is one of the few countries where declining population levels have strained labor markets even more acutely than in Russia. As a result, Ukraine’s manufacturing sector lacks the manpower needed to compete with those in European countries.
“Nearly half of E.U. 27 exports to Ukraine in 2007 were machinery and vehicles and a further quarter were other manufactured articles,” according to data released last week by the European Commission.
Needless to say, machinery and vehicles are also the leading categories of European exports to Russia. Since 2000, the number of European cars sold in Russia has risen by 34%. Last year, Russia surpassed Japan as the second largest export market for European automakers, accounting for nearly 10% of all Europe’s car exports.
Meanwhile, European imports of Russian cars have fallen from 70 million euros in 2000 to 36 million euros in 2007. So much for Russian manufacturing. When you’ve got euros in your pocket and Europe on your border, who needs factories anyway?