How big is the Russian economy?

Surprisingly, it is possible to find considerable disagreement over what is seemingly a simple matter of fact. This confusion is caused by which method one chooses to convert the GDP of any country in terms of its national currency (in this case the ruble) into a common currency (in practice, usually the U.S. dollar).

It is perfectly acceptable, for instance, to state that, at $1.6 trillion in 2017, the Russian economy is not even in the world’s ten largest economies, instead being roughly comparable in size to Australia. This is true if GDP is measured at prevailing market exchange rates, i.e. using the current ruble/U.S. dollar exchange rate. But it is equally acceptable to state that, at $4 trillion, the Russian economy is the sixth largest in the world, only slightly smaller than Germany’s ($4.1 trillion). This statement is true if Russian GDP is converted into dollars at purchasing power parity (PPP) exchange rate.

Much, then, depends on the choice of measure. While the market exchange rate conversion is intuitively easy for most non-economists to understand, the PPP method of conversion is not so easily grasped.

To understand PPP, The Economist magazine’s widely known “Big Mac” index is often used to illustrate how living costs vary across the world, even for purchasing near-identical products. If a Big Mac is sold for 120 RUB in Moscow and $5 in Washington, D.C, this would suggest a PPP exchange rate 24 RUB to the dollar. After all, identical products are being sold in both Moscow and Washington.

But the market exchange rate often differs considerably from the rate suggested by a PPP calculation. Today, the RUB/$ exchange rate is closer to 70 RUB to the dollar. The reason for this variation is usually to do with the differences in costs of inputs required to make the Big Mac: in Russia, input costs (e.g. labour, ingredients for burgers, and so on) are lower compared with those in the US, which means that, on average, the ruble can buy more goods and services in Russia than might be expected if using the prevailing market exchange rate.

Of course, any meaningful comparison of prices across countries should be based on a wider range of goods and services than a simple hamburger. This represents a mammoth statistical task. Measuring the relative price of, say, a Su-57 and an F-35 would require knowledge of a multitude of input prices, including labour and components, many of which may have been imported and therefore embody higher relative costs from other countries.

Nevertheless, the UN and IMF have made efforts to do just this, and as a result, PPP ‘weights’ are available that allow analysts to make estimates of the size of an economy that adjusts for differences in living costs.

Today the IMF calculates an implied PPP exchange rate of 23.40 RUB to the dollar – note that this is nearly identical to the Big Mac example given above. Given the actual market exchange rate is nearly 70 RUB to the dollar, this would suggest that the Russian economy is nearly three times as large as that implied by the market exchange rate.

While the discussion so far may seem arcane for non-economists, there are good practical reasons for knowing which measure is appropriate to use, and thus to better understand Russian economic power and capabilities.

Generally speaking, market exchange rates are the logical choice when financial flows across borders are being measured. For example, the current account or trade balance – both of which measure the funds entering or leaving a country – represent flows of financial resources across countries. It is appropriate to use the market exchange rate to convert these flows into dollars when aggregating across regions or calculating the global current account discrepancy.

But for other variables, it is often more appropriate to use PPP-based measures. For example, while market- based rates are appropriate for measuring the value of internationally-traded goods, non-traded goods and services tend to be cheaper in lower-income countries, especially large, populous countries like Russia: the price of an Uber taxi ride of the same distance is higher in London than in Moscow, for instance. This is because wages tend to be lower in lower-income countries, and services such as Uber, are relatively labour intensive.

Any analysis that fails to take these differences into account will underestimate the purchasing power of consumers in lower-income countries.

It is possible to use PPP-based measures to estimate other economic variables beyond the simple size of an economy. One variable that should be measured using PPP is Russian military expenditure.

This is often expressed in current dollars in widely-known publications by SIPRI and IISS. Thus, according to SIPRI Russia spent around $66 billion on the military at market exchange rates in 2017. By comparison, the UK spent $47 billion in the same year.

Yet Russia maintains armed forces of around a million servicemen compared with a figure of fewer than 200,000 in the UK.

Russia also procures and maintains far larger volumes of equipment across the whole spectrum of military production, including intercontinental ballistic missiles, nuclear-powered submarines, and state-of-the-art helicopters and fighter aircraft. And it regularly conducts major military exercises and operations.

Maintaining and equipping such large and capable forces only makes sense when we remember that most of the costs borne by the Russian state are denominated in rubles and not dollars. Using PPP-based measures to calculate Russian military expenditure would yield a figure of closer to $200 billion, a sum that makes much more sense given the wide range of military goods and services bought by the Russian state each year.

And this is because, quite simply, a ruble buys relatively more military output in Russia than a dollar does in the U.S. This simple observation should be borne in mind when seeking to understand how Russia’s sluggish and seemingly stagnant economy can support such a large and capable military.

Source: Oxford Russia Brief