PCM analysis, 28 Sep 16
Seeing the wood for the trees
It is now twenty years since the launch of the Russian Prosperity Fund and twenty-three years since I first started investing in Russia. Often, people ask me how the outcome compares with the expectations I held when we started.
It is, of course, not entirely easy to remember what I thought then of what would happen but, perhaps somewhat surprisingly, it was not so far from the reality is. We expected Russia to become a modern country, much more similar to developed counties, and for the companies in which we invested to become more efficient and profitable. Often, we heard Russians say that they wanted Russia to become a ‘normal’ country. It is not fully clear what that means, but it is very clear that they have come a long way toward this goal. I lived in Moscow for seven years - raising my children in the city over that time - and have visited more than one hundred times since I moved away. I still well remember the chaotic, but exciting place that we moved to in those early years, where nothing and everything worked. When we arrived there was only one modern food store in the whole country, very limited communications, no real taxis, the airlines and hotels were not for sensitive travelers. The companies had next to no transparency, share transactions had to be re-registered manually - often in Siberia - and share quotes were faxed amongst brokers. Most exporters also exported their profits to offshore sister companies. It was not always easy to either live in Moscow or to invest in Russian companies.
Now, Moscow is a very welcoming city with all of her amenities and attractions. Regional cities are not far behind. Every conceivable consumer good is available and everything is digitalised for convenience. There are high-quality restaurants and hotels at reasonable prices and service levels are comparable with any major city. Russian companies are now arguably more transparent than their western counterparts and the stock exchange works as smoothly as any in the world. Russia has come a long way.
What is driving all of this? What does it mean and where will we go from here? There are many contributors, but most important is clearly productivity. The link between productivity and prosperity is so close that one can almost say that it is the same thing. Productivity is, however, one of the most difficult things to measure correctly. It was easy when all one needed was to calculate factory output, but as services have become the mainstay of most economies it has become trickier - particularly with public services. Whatever measure one chooses, it is very clear that a major shift has happened in the world economy when it comes to productivity. Twenty years ago, the world was much simpler. The developed world had high productivity and was wealthy and the emerging world had low productivity and was largely poor. The latter category certainly included Russia, even if Russia - as opposed to many other emerging countries - was industrialised, urbanised and generally well-educated. Since then, the West has essentially no productivity growth and no real GDP growth outside of population growth. Real GDP per capita has been stagnant for the last eight years. Policy makers have tried to rely on unprecedented monetary stimulus in an attempt to generate economic growth in the absence of real productivity growth. It has not worked.
On the other hand, in emerging countries, including Russia, one has seen striking productivity growth. As mentioned, it is not always easy to measure productivity, but looking around one can clearly tell that more is being produced in terms of both goods and services. This absolute and relative productivity growth is the core of the story that we are trying to tell.
One can often read stories in the press about how Russia is in decline, on the precipice of some collapse and facing a dead-end. At the end of this Prosperity Newsletter, I enclose a rebuttal of such an article. I chose the one that I have not because it is much worse than others, but because the author, Thomas Friedman, is very highly regarded. It is loaded with manipulated and misleading ‘data’. I still find it hard to fully understand why otherwise reputable journalists, like Friedman, would willingly mislead their readers. Perhaps my argument is harshly formulated, but the data can very easily be checked and there is no doubt about who is right and wrong in this case.
There are many different aspects of the improvements that we have seen over the last twenty years and it would be easy to focus on corporate profitability and dividends, which are, naturally, our main interests as investors. Many investors, however, are also concerned with broader issues and have some difficulty reconciling the picture that we paint with impressions relating to political factors. We generally try to stay out of political discussions, but still seek to explain how things look from the Russian side. Later on in this Prosperity Newsletter we have shared our thoughts on geopolitics over the last twenty years and now.
On the domestic political front, there are a number of things that may help to explain the current standing. Putin’s popularity has three legs. Most have focused on the most obvious one; the Russian people are much better off now than when he came to power. US dollar salaries are more than ten times what they were and there is hardly any unemployment. Most commentators have not come further than this and are surprised that Putin is not less popular now, as things have been a bit tougher of late with two recessions in the last eight years.
The second leg of Putin’s popularity is probably even more important than the first. The Russian society now functions far better than it did. The 1990s were chaotic and many suffered greatly. Public services declined dramatically. In the last sixteen years, all of this has turned around. It is hard to measure productivity and efficiency in healthcare and education, but it is very clear that things are now improving. One dramatic measure would be infant mortality; we have seen infant mortality decline by 65 percent - this does not happen by chance. It happens because the healthcare system works better and parents are better able to care for their children. The average lifespan has increased by more than six years in the last tweleve years. These are very striking numbers and this rate of improvement is very unusual globally.
We also see other signs. There has been a real drive toward e-government and on the Ease of Doing Business measures. Russia has improved on all sorts of rankings, as can be seen from the below listed examples. Education has increasingly been taken online, with each school and pupil now having their own online portal. All of these things add to the sense of wellbeing for the Russian population. Anyone who has regularly visited Moscow will also have noted the clear improvements in the cityscape. Roads, parks, pedestrian areas, sports facilities and much more have improved. Many other Russian cities have seen similar moves forward and those falling behind are increasingly getting into trouble. One of the most pervasive remaining problems is corruption and this is often mentioned in rankings of peoples’ complaints. In the last few years we have seen real action on this also and the list of people caught – including high ranking ones – is steadily getting longer. By now, people are probably concerned enough to change their behavior. This is still a work in progress and we will see what the outcome will be.