An important factor behind the differences in shares between the current and constant price series is due to the importance of oil exports. The constant price data measure exported quantities, while the current price data measure export values and are therefore subject to changes in both international oil prices (measured in dollars) and changes in the exchange rate (since the accounts are in ruble). Since GDP shares obviously have to add up to 100% (at least when the statistical discrepancy is taken care of), if exports develop very differently for the current and constant price series, so will all the shares, including investments to GDP.
Instead of focusing on how the share of investment in GDP develops, we can look at the growth rate of investment, which is not subject to an adding up constraint. To avoid having inflation that has varied greatly over the years distorting the analysis, growth should be measured in real terms. This implies using either the constant price series or taking the current price series and converting it to dollars with the idea that the exchange rate will move in a direction opposite to that of inflation and provide a measure that is closer to real growth in investments. Since the next step of the analysis involves exploring how capital flows (which are measured in dollars in the balance of payments statistics) are related to investments, the focus will be on how investments measured in dollars have evolved.
The first observation from Figure 4 is that the growth of investments has varied greatly since the start of transition, which is not surprising given the growth charts we have seen. As expected, investment is more volatile than growth but since we are looking at growth in dollar terms, both series display a very high degree of volatility. Although the initial years of transition were particularly volatile with the initial investment boom followed by the 1998 crash, more recent quarters also display growth rates going from plus to minus 40%, which of course is linked to significant changes in the exchange rate.5
Figure 4:Investment and GDP growth.
Note: Growth is calculated from the same quarter last year on GDP measured in current terms and converted to USD by using quarterly exchange rates.
Source: Federal Statistics Service and author’s calculations.
What are then the factors that drive changes in investment? In many transition countries, foreign direct investments have been important drivers of investment and growth (see Mileva, 2008). Russia has of course received large foreign investments since 1991, but in many empirical studies of FDI, Russia receives significantly less than what could be expected for an economy the size of Russia.6 The question here though is whether the FDI that comes to Russia has a significant impact on investments in fixed capital at the macro level. In addition to FDI, we can expect that changes in international oil prices will affect investment growth just as they explain overall growth of the economy. Finally, institutional factors that are thought to affect the investment climate could impact investment growth. Table 2 shows the result from running linear regressions on changes in investments on changes in oil prices, changes in foreign direct investments and changes in institutional factors as measured by the EBRD’s transition index and a composite index based on the World Governance indicators on rule of law, control of corruption and regulatory quality.
The main result from this is that foreign direct investments do lead to higher investments as do increases in oil prices. The coefficient on FDI is larger than 1, which suggests that there are positive spillovers from FDI to other domestic investments (or crowding in rather than crowding out of domestically financed investments) similar to the finding in Mileva (2008).
At the same time, the amount of FDI is relatively small compared to overall investment and the share has fallen dramatically since the global financial crisis, from a peak of over 20% in 2007 to around 5% in 2018. FDI can also play an important role in modernising and diversifying the economy since foreign investments can be associated with important knowledge transfers in terms of both technology and management practices that can facilitate a structural change of the economy. Therefore, attracting FDI should be high on the list of any policymaker that is serious about generating growth and diversifying the economy. However, the institutional factors fail to generate any significant impact on investments, which is counter to regular arguments on the importance of institutions (see, e.g., Roland, 2000 and Gorodnichenko and Roland, 2016). This can be a result of insufficient variation in the institutional variables over this time period or that the simple analysis here does not account for more complicated causal stories. This may lead to problems with endogeneity with the institutional factors, and this part of the analysis should not be taken too literally for this reason. However, there is clearly an empirical regularity between inflows of foreign direct investments and investments in fixed capital at the macro level that warrants a closer look at capital flows.
Table 2:Correlates of investments.
Note: All variables are changes in the respective variable.
Source: Author’s estimates based on data from Central Bank of Russia, EBRD, World Governance Indicators and US Energy Information Administration.
Capital Flows
Capital flows are an important link between the domestic economy and global markets in any country. The role of capital flows is not only to finance investments, transfer knowledge and generate growth at home, which is the main focus here, but also to facilitate consumption smoothing and risk management. The latter reasons for international capital flows are likely to have been highly important to understand capital flows between Russia and the rest of the world. The composition and magnitude of flows can provide important signals on how both residents and foreign entities view the growth prospects of a country as well as the functioning of financial markets and the institutions that protect property rights.7 In emerging markets, sudden reversals of capital flows (sudden stops) have been shown to be the costliest shock that these countries face in terms of loss of income at the macro level (Becker and Mauro, 2006).8 This suggests that avoiding sudden stops is a key factor for long-term growth and macroeconomic stability.
Figure 5:Private sector capital flows.
Source: Central Bank of Russia.
Figure 5 shows private capital flows in the form of foreign direct investments (FDIs) and portfolio, loans and other flows (PLO).9 Inflows and outflows are shown separately for each category, and note that for the PLO flows, both inflows and outflows can (and do) take on negative values. A number of observations are worth mentioning here. First of all, the PLO flows are both greater in absolute terms and much more volatile than FDI flows. This is very much in line with the discussion about “hot money” flows to emerging markets that say that FDI flows (“good cholesterol”) are more stable and beneficial for growth, while portfolio flows and loans (“bad cholesterol”) are volatile and associated with the problems of sudden stops discussed earlier (see Fernandez-Arias and Hausmann, 2000). The Russian story seems to be in line with this reasoning, given that large portfolio and loan inflows are in many