Russia’s Physical and Social Infrastructure:
Implications for Future Development

Conference Report
December 2000

This seminar series was sponsored by the National Intelligence Council (NIC) and the Bureau of Intelligence and Research of the US Department of State. The NIC routinely sponsors unclassified conferences with outside experts to gain knowledge and insight and to sharpen the level of analysis and debate on critical issues. The views expressed are those of individuals and do not represent official US intelligence or policy posistions.

Executive Summary

Introduction
During the past two years, the National Intelligence Council and the Bureau of Intelligence and Research of the US Department of State sponsored a working group and four seminars with experts from outside the Intelligence Community to examine the impact of societal and infrastructural factors on Russia's future over the next two decades. The factors identified--demography, health, intellectual capital, and physical infrastructure--all pose great challenges to Russia. The purpose of the project was to begin to think through in systematic fashion the difficulties and opportunities confronting Russia's leadership in these four specific areas.

Key questions with which participants grappled included: What is the extent of the challenge in each of these areas? What are the trends, and to what extent are the outcomes of these trends over the next 20 years already determined? What are the key drivers that can influence these trends? When could government policy intervention or outside assistance be expected to have payoff, and how costly would it be? Is there a logical sequence of priorities for attention? What are the implications of alternate paths?

This report consists of three substantive sections. This Executive Summary is the first; it captures the main findings of the presentations and discussions at the seminars. The second is an essay by Marcus Noland, Senior Fellow at the Institute of International Economics and project adviser, who explores these themes in greater detail. The third section contains brief summaries of the papers presented at the seminars. The agendas of the seminars and lists of speakers follow in the appendixes.

Key Findings
Most of the challenges confronting Russia in the spheres of social and physical infrastructure are not unique. It is the confluence of so many challenges all at once--initiated by the abnormal existence and then the breakup of the Soviet Union, intensified by the stormy transition in Russia over the past decade, and then exacerbated by the collapse of the ruble in August 1998--that makes the Russian case extreme.

Demographic Trends
Experts noted that demography is one of the most reliable factors that can be used to make projections about a specific country. Demographics can help answer some narrow questions--such as likely pension burdens--and can sometimes be helpful with "middle-gauge" questions, such as future health care costs or housing markets. Demographics generally are not reliable or insightful for other questions, such as homicide rates or generational conflict. In Russia's case the unique nature of the demise of the Soviet empire may place Russia outside the normal range of historical experience, moreover, and limit the predictive value of demographics.

Experts agreed that the combination of high Russian mortality rates and low birth rates will affect Russia profoundly in the coming decades.

• The causes of early mortality are numerous, and include high rates of suicide, childhood injuries, alcoholism, infectious diseases, cardiovascular disease, and cancer. Some trends result from the reduction of the state's involvement and the absence of private structures to replace it, especially investment in medical technologies and drugs. Many health problems are the result of a health care focus on communicable diseases and nutrition without corresponding attention to prevention of chronic diseases. Experts disagreed as to whether economic improvement--which could bring enhanced nutrition, better water supply, and a reduction in crowded living conditions--would be sufficient to reverse negative health and demographic trends.

• Russia is following the general European downward trend with regard to fertility. Overall, Russia's total fertility rate stands at 1.17, and some believe that it can reach as low as 1.0--well below replacement level of 2.14. All agreed that it will not rise higher than 1.5 over the next 20 years. Russia's abortion rate remains extremely high, and noted demographer Murray Feshbach claims that thirty percent of Russian women of childbearing age are infertile.

Internally, population growth among Islamic peoples of Russia, many concentrated in Russia's south, continues to outpace that of ethnic Russians, while Northern and Far Eastern regions are slowly being depopulated as state-owned industries close and people move to European Russia. As a factor in population growth, immigration has outweighed emigration since the breakup of the former Soviet Union; barring civil wars or other disasters in the near abroad, it has probably peaked.

By 2020, Russia's population is most likely to be smaller--according to Feshbach, it is very likely to decline from 146 million to 130 million in this timeframe--and with a higher median age than today's. Russia's State Committee for Statistics recently forecast that the population will shrink to 134 million by 2015. As Russia's population ages, an increase in the dependency ratio is certain: by 2015 the ratio will be just four workers for every three nonworkers, with a dramatic shift among the nonworking population toward the elderly. The aging of the population and the increase in the dependency ratio suggest that domestic public and private capital available to refinance new investments may decline over the next two decades, underscoring and increasing the importance of creating the necessary conditions to attract investment from abroad.

Among Russia's labor force, unemployment as a result of economic decline has hit the female work force disproportionately. This increasingly unused resource could compensate for Russia's dwindling number of males, should a Russian economic recovery require additional labor.

Seminar participants saw both positive and negative implications of Russia's declining population.

• From a military manpower perspective, Russia--which already lost much of its mobilization base with the independence of the former Soviet republics--will find it increasingly difficult to generate and deploy the large conventional forces it has historically relied upon to defend its borders. The manpower shortage will contribute to Russia's increasing reliance on its nuclear deterrent.

• Internal migration will result in changing regional dynamics and possibly in the concentration of the Russian population into a smaller number of regions. The population of some regions, such as the Far North, will most likely decline further as the Russian Government no longer continues to bear the high cost of maintaining infrastructure in areas where the economic base is not largely self sustaining. In the increasingly depopulated Far East, Moscow's concern about the security implications of Chinese in-migration will heighten.

Health Trends
Another factor influencing Russia's future demographic path for the worse--possibly making today's grim predictions appear optimistic--is the Russian health crisis. Seminar participants agreed that the list of Russia's health woes is extensive: continuing high rates of alcohol abuse with a resulting abundance of new fetal alcohol syndrome cases; pharmaceutical shortages; poor reproductive health and continuing high rates of abortion; rising rates of infertility; high rates of sexually transmitted diseases; cardiovascular diseases; anemia; poisoning from heavy metals and other toxic materials; environmentally associated cancers; high rates of injury; and malnutrition. One speaker pointed to the toll on health resulting from growing inequality in Russian society and associated stress, deprivation, and breakdown in social cohesion; another, however, warned of the methodological difficulty of differentiating causality from correlation in assessing the root of some health problems.

Experts noted that infectious diseases with the potential to spread beyond Russia's borders are growing rapidly.

• While registered cases of HIV have grown to some 53,000, estimates by Russian experts of the real incidence range from 10 to 100 times as many.

Russia's medical establishment is badly positioned to cope with the challenges it faces. It is still overcentralized, overspecialized, hierarchical, and strongly shaped by the beliefs and practices of the Soviet era. Health expenditures are treated as a residual claimant on the Russian budget, a problem compounded by the inefficiency of Russian health care delivery. "Therapeutic anarchy" and a reliance on what one speaker euphemistically called "non-evidentiary-based medicine" are widespread. Most key decisionmakers in Russian medicine have strongly resisted change and Western advice, even when practitioners accepted such advice, they have lacked the organizational capacity and resources to carry through on treatments, as in the case of tuberculosis.

Russia's economic crisis has exacerbated many of the health problems. Shortage of resources has led to cuts in health spending and low salaries only irregularly paid to health-care workers, whose morale has plummeted. Russia's experiment with a medical insurance scheme has met with uneven success to date, although it has succeeded in keeping the decline in health expenditures to a lower rate than that experienced by other sectors such as education and culture. In addition, frequent bureaucratic shakeups have resulted in eight different health ministers since 1995, making consistent policy difficult to sustain.

A few seminar participants thought that a new generation of medical leaders will be more open to change. The majority, however, appeared unconvinced that an attitudinal shift could take place with sufficient magnitude and speed to prevent a serious deterioration in Russia's already abysmal health picture.

Finally, experts agreed that the trends in Russian health are of significance not simply for their negative demographic ramifications, but also for their probable strong negative impact on the future productivity of Russia's work force and its overall quality of life.

Trends in Intellectual Capital
Experts agreed that Russian intellectual capital is under a high degree of stress.

• Russia's schools have deteriorated significantly, and many lack teachers in basic subject areas, especially in the poorer regions.

• Russia's science and technology base--greatly shrunken from the oversized Soviet complex but not disproportionate to Russia's present size--is inadequately funded and not attracting sufficient new talent.

• Russia has been losing significant expertise to a "brain drain" for over a decade.

Significant recent growth in some forms of education will prove critical to Russia's emerging market economy. Enrollment in newly created business schools and management training courses is thriving and could result in significant future payoff. In addition, the growth of the Internet and global communications has provided new opportunities for more effectively organizing education across Russia's wide expanses as well as for absorbing knowledge from abroad. Recent tightening of controls over information flows--such as media, publications, and computer mail--raise questions, however, about Russia's future ability to benefit from greater interchange with other countries.

Russia's ability to recover from the damage to its intellectual capital during the last decade will play a key role in its ability to compete in future world markets. Given that the majority of Russians who will be in the labor force for the next two decades have already received their formal education or will soon do so, many changes in educational policy today are likely to bear fruit only at a later date. Some experts argue, however, that the educational system is not a leading indicator of change and not the place to start. Globalization presents other paths to technological success through adaptation rather than innovation, and improvements in education tend to follow naturally upon economic growth.

Trends in Physical Infrastructure
Russia's physical infrastructure reflects the legacy of Soviet-era priorities and relative Soviet autarky, ensuring that the transition to a new, more globalized economy will be difficult. Although assessments vary, many experts believe that a large proportion of Russian capital stock will have to be written off over the next decade. Investments have been made in industries in which Russia is unlikely to ever be internationally competitive, either because of poor quality or because the capital stock embodies technologies incompatible with international standards. Considerable capital has been invested in remote regions where neither the government nor private industry is likely to provide funds for upkeep or modernization. Demonetization, lack of institutional capacity, and inadequate property rights protection discourage investment in both public and private spheres.

The picture is mixed, however. In industry, some studies, such as that by McKinsey Associates, have found the potential for productivity improvement in many sectors. In housing, privatization appears to have given a boost to new construction, although the 1998 financial crisis interrupted this trend. In the transport sector, the extensive shakeout of Soviet-era bureaucracies, enterprises, and infrastructure that has taken place and is still occurring was necessary, but the potential for new companies to find new niches also seems high, if economic recovery continues.

Conclusions
Participants found that while the impact of certain trends, such as worsening demographics, is largely unavoidable for the next two decades, the Russian Government does have the capability, if not yet the demonstrated determination, to reverse or slow other negative trends in this timeframe. In some cases, timely action is required to prevent long-term adverse consequences. For instance, public policy decisions and directed resource flows could make a difference in education and health. Regional policy--from the center or decided locally--can also have great impact, and, together with other factors such as geography and resource wealth, could serve as a magnet to concentrate Russia's population into a smaller number of "winner" regions. And as with most other problems in Russia, the new leadership's ability to establish a predictable legal and fiscal environment--essential for ensuring economic stability, attracting private investment, and ultimately, stimulating economic growth--would increase Russia's ability to reverse many of these negative trends.

Marcus Noland
Institute for International Economics

While much has been made of adverse trends in the health and size of Russia's population, even by Russian President Putin himself in his first State of the Union address, the implication of these and other trends in Russia's physical and social infrastructure--its human capital and physical infrastructure--is less well understood. This paper draws upon lessons learned from the recently concluded seminar series to draw some preliminary conclusions about how these factors and their interactions will affect Russia's future economic and political development.

Demographic Trends
Although Russia has been below zero population growth for over 30 years, its population has been in a decline so steep over the past decade that it is outside the range of its previous historical experience except for wartime.

The Total Fertility Rate (TFR)--the average number of children a woman would have over her lifetime if she reflected the age-cohort adjusted fertility rates for a specific year--is considered the best indicator of the birthrate, with simple population replacement--or zero population growth--equating to a TFR of just over 2.14. Russia's TFR dropped sharply between the late 1950s and the early 1960s, then began to fall precipitously in 1991, reaching 1.17 in 1999. In the core ethnic Russian areas of the country, TFR is even lower, standing at just above 1.0 with some major urban areas reporting TFR below 1.0. The TFR in non-Russian ethnic areas, by contrast, exceeds replacement, sometimes by a wide margin. It should be noted, however, that infant mortality rates in these areas (in the 30-35 per 1,000 range) also exceed the already-high rates in ethnic Russian areas (17 per 1,000 in 1998 for Russia as a whole), so the differences in TFR across ethnic groups may overstate effective differences in population growth rates.

Continuation of TFR differentials across ethnic groups implies long-run shifts in the ethnic composition of the population. Between now and 2015, of Russia's 89 federal regions, only 12 areas--with substantial non-Russian populations--are projected to show population growth, though actually observed growth may be reduced by regional outmigration.⁽²⁾ Given the relatively small percentage of total population that ethnic minorities represent in today's Russia, however, the impact will not be very large over the twenty-year horizon of this paper.

The causes of the decline in Russia's TFR, especially over the past decade, have been the subject of considerable argument.

• Others argue that the decline is part of a long-term trend toward smaller families. The history of the Russian TFR demonstrates the presence of a long-term trend that pre-dates the collapse the Soviet Union, and recent sociological research--which shows only a small gap between the number of children people "wish to have," the number they "expect to have," and the actual number they do have--suggests that the pro-natalist policies of the 1980s merely advanced the timetable on which people had children without affecting the number of children they wished to have. Russia's TFR, although low by Russian standards, is comparable to current rates in some Western countries.

Another factor that should be considered in assessing the likelihood of a rebound in Russia's TFR is the apparent increase in both reproductive health problems and infertility, which affect an estimated 15 percent of Russian couples. The broader scientific community is conducting research to gain a better understanding of the extent of reproductive health problems in Russia and their causes.

^aBrian Carnell, "Total Fertility Rates for Europe and the NIS," www.carnell.com.population/tft_europe
^bRussia's TFR in 1999 fell to 1.17

The consensus among experts consulted is that Russia's TFR is likely to remain in the range of 1.5 (roughly equivalent to today's Western European levels) to 1.0, but it must be conceded that demographers do not have particularly good models of the social determinants of fertility. Thus, barring a large influx of population from elsewhere, the Russian population is expected to continue its numeric decline over the next 20 years. Moreover, given current mortality rates (see below), by 2030 the median age of the Russian population will be over 40, with half the population having been born before the year 2000.

Mortality Rates and Public Health. While fertility rates have been declining, mortality rates have been rising. As with the fall in fertility, the fall in Russian life expectancy began in the Soviet period and accelerated after 1989. The period through 1993 saw a steep rise in age-specific death rates for both genders and for all age groups with the increase among working-age males particularly dramatic. By 1999, Russian statistics show life expectancy for men at 59.3 years and for women at 71.7 years.

As with fertility rates, regions vary considerably with respect to mortality rates, with death rates among the working-age populations of Siberia and the Far East 20 to 30 percent higher than the national average. Moreover, across Russia rising mortality rates are statistically correlated with relative economic inequality, not just with absolute declines in real income. The leading causes of death among Russia's working-age males are accidents, other trauma, and poisonings, including those associated with the consumption of alcohol and alcohol substitutes.

More broadly, deteriorating living standards--declining water quality and other environmental degradation, a worsening diet, less accessible health care--along with unhealthy lifestyle choices such as smoking, abusing alcohol, and practicing unsafe sex, have had a profound impact on the health of both males and females in Russia and have contributed to growing rates of infectious diseases. Only scientific research can determine whether the population's exposure to environmental pollution has weakened their immune systems.

Tuberculosis and sexually transmitted diseases are especially worrisome. TB is well above epidemic proportions with both the very large prison population and medical personnel exhibiting extremely high infection rates. The apparent inability of the Russian health care establishment to handle the TB problem has contributed to the widespread fear that Russia is emerging as the prime incubator of drug-resistant strains of the disease. The number of reported cases of sexually transmitted diseases, including HIV/AIDS, is growing rapidly, and Russian authorities admit that the number of reported cases is but a fraction of the actual number. Even regions far from metropolitan centers report rapidly growing rates of infection. In Irkutsk, for example, reported cases jumped from 68 to more than 2,000 during the course of 1999.

The interaction between TB and HIV/AIDS, the flourishing sex trade in Russia and certain other NIS countries, and the growing rates of IV drug use all magnify the rate at which these diseases may spread. With an estimated 1.75 million children abandoned by their families in recent years, large numbers of very young females engaged in the sex trade, and IV drug use concentrated among younger people, the impact of these twin epidemics will fall most heavily on Russia's relatively small cohort of young people, further narrowing the demographic base.

In addition to the rise in infectious diseases, Russia faces other serious health problems:

• Russian military officials routinely complain about the declining physical condition of young people in general and of draftees in particular and are currently reporting that one in three draftees is seriously underweight because of malnutrition. The military's reports of widespread malnutrition are given credence by the fact that per capita caloric intake dropped from 3300 to 3400 kilocalories per day in 1991 to 2400 to 2500 in 1997 and by reports of vitamin deficiencies of 20 to 50 percent depending upon the specific vitamin.

The multiple and complex causes of Russia's increased mortality rates suggest that it would be exceedingly difficult to design public policy interventions to reverse these trends. Nonetheless, there are grounds for guarded optimism. In Russia, the antialcohol campaign of the late 1980s appears to have had a demographically significant effect on health status and mortality. Examples from other countries--the United States' experience with tobacco or successful government-backed anti-AIDS campaigns in some countries, some of which have lower incomes and social capacities than Russia--demonstrate the positive impact that public policy intervention can have. Today's high rates of infant and maternal mortality, for example, are problems that could be addressed by concerted government policies.

Increased Dependency Ratios. As Russia's population ages, statistics show a likely increase in the dependency ratio (the ratio of the noneconomically active to economically active population) beginning around 2010. By 2015 there will be just four workers for every three nonworkers, with a dramatic shift among the non-working-age population toward the elderly. Indeed, the net increase to the working-age population will continue only until just after 2005, at which point, barring a very large net gain of working-age people through immigration, the size of that population will begin to decline. Given the declines in births over the past decade (from 2.1 million in 1989 to 1.2 million in 1999), the decline in the working-age population is unlikely to bottom out before 2017 at the earliest.

However, for a bottoming out to occur, a very large and rapid increase in the number of births and/or significant immigration from abroad would have to occur. Ironically, a rapid rise in the number of births would exacerbate the dependency ratios over the short term, as both the below-working-age and the above-working-age populations grow. The rising dependency ratio under either scenario may depress the national savings rate and reduce future domestic resources available for investment. Moreover, increasing cross-regional variation in the dependency ratio is likely as a result of economic restructuring and internal migration. This increased variability in the dependency ratio in various locales could intensify internal political tensions.

Migration. Cross-border population movement could offset or exacerbate demographic trends in Russia. During the period immediately following the breakup of the Soviet Union, Russia experienced relatively high levels of both legal and illegal immigration and emigration, with net immigration peaking at nearly 900,000 in 1994. A majority of outward-bound migrants were ethnic Germans or Jews joining communities abroad. Inward-bound migrants, who tended to be somewhat older than the Russian population as a whole, were largely ethnic Russians leaving parts of the former Soviet Union, often fleeing civil strife. This ethnicity-based cross-border population movement appears to have largely played itself out, and since a spike following the ruble crisis of August 1998, Russia has experienced reduced levels of both immigration and emigration, with annual in-migration running below 400,000--a contributor to population size, but not enough to offset the decline in the natural population.

That said, a very large Russian diaspora remains in the other countries of the former Soviet Union, and political instability in those countries or the appearance of a large and growing gap in economic well-being in Russia's favor could generate considerably higher levels of immigration. Conversely, a worsening of political or economic conditions in Russia could lead to increased emigration, especially of the highly skilled.

One other demographic factor that will have an impact on the shape of Russia in 2020 is internal migration. Since the end of the Soviet Union and its system of heavy subsidies to encourage people to move to otherwise undesirable regions, there has been a large and continuing out-migration from climatically harsh or economically depressed regions, especially from the Far North, the Far East, and Siberia. This out-migration is expected to continue over the next 20 years: from 1995 to 2010 the majority of administrative regions in the Far East and Siberia is expected to suffer major population loss, some as much as 30 percent. In the case of the geopolitically sensitive Far East, the fact that the exodus is heavily weighted toward young adult males and young families has potentially serious economic and security consequences. Increasing concentrations of the elderly in these regions will place additional economic stress on local governments.

The exodus of young males and young families from the Russian Far East also means that the region would soon encounter a labor shortage that probably would have to be overcome through the importation of labor from Asia, especially from China and North Korea. There is already some use of Korean labor in the region, and even today's modest Chinese presence has stirred up anti-Chinese sentiments, which have been exploited by local politicians. A much larger foreign presence would be fraught with social consequences. The sizable population losses that are projected for the Far East, and especially the loss of young males, also will have an impact on Russian military planners. The shortage of mobilizable manpower in this vast and strategically important region will mean that, if required, military manpower will have to be mobilized well to the West and transported into the Far East.

Labor Force and Human Capital
For a decade we have observed the decline of the Soviet economic system without the creation of a robust alternative. The ongoing transformation of the Russian economy has had profound effects. Overall employment has declined, though Soviet-era practices encouraged some overemployment. The regional, sectoral, and occupational pattern of employment has changed considerably. As discussed above, outmigration from the Russian Far East and North have left those regions either dependent on foreign workers or forced to accept labor shrinkage. Industrial employment has declined while service sector employment, especially in business and finance, has increased. Women's employment has fallen disproportionately, even though the sectors of greatest employment reduction--industry and construction--were the sectors where women were most underrepresented relative to their overall labor force participation. New entrants to the labor force are far more likely to seek careers in business than in public-sector occupations or in science or industry. Not surprisingly, changes in the demand for labor have also been manifested in changes in wage rates.

These labor market trends reflect a combination of transition away from the Soviet-era economy and worldwide technological changes. To a certain extent, policy measures might be undertaken to offset these trends, for example, by subsidizing the consumption of products produced in Russian industrial enterprises or providing subsidies to enterprises in distant regions. Whether such measures could succeed in reversing such fundamental forces is doubtful, however. The relevant questions may be how much longer can this process--essentially driven by the decay of the old system--continue, and how rapidly can an effective alternative system be built?

Globally, technological change has increased the wage premium associated with educational attainment and the acquisition of economically relevant skills, which may or may not be narrowly "technical" in nature. Russia is no exception. Technological change and the transition from the Soviet-era economy have generated increased wage and wealth inequality, increasing income to those well placed to meet the new demands of the marketplace and reducing income in absolute terms to the low-skilled and those in declining sectors. Throughout Russia, unemployment is inversely correlated with educational attainment. Skill formation is absolutely essential to success in the 21st century economy at both the national and personal levels.

The existing Russian educational system provides high-quality education for the elite but mediocrity for the masses. State subsidies to elite education are quite large. In terms of indicators such as years of schooling and per-pupil expenditure, Russia is firmly among the ranks of middle-income countries such as the Philippines, Thailand, and Uruguay.

The Russian work force currently appears to have enough engineering talent to efficiently adapt technological innovations produced abroad--a hallmark of economic development among "follower" countries--but this may not continue to be true. School enrollment rates at all levels have trended downward since 1989, though there is some evidence of bottoming out or trend reversal since 1995. State expenditure on education has similarly fallen. Even for elites the quality of education has deteriorated, as skilled instructors have emigrated or left teaching for other pursuits. This phenomenon has affected not only the universities but also other state-supported scientific institutions as well. At the same time, a reorientation of education toward more relevant skills--business and accounting, for example--has occurred as well as a growth in market-responsive private educational and training institutions. A small number of the elite is educated abroad.

That said, changes in educational policy may have a relatively limited impact on the labor force over the twenty-year horizon of this paper. The vast majority of Russians in the labor force of 2020 have already received their formal education or will soon do so. As a consequence, changes in the quality of schooling, for better or worse, may have only a marginal impact on the skills embodied in the work force of 2020.

Labor market and human capital development should not be viewed solely through the narrow prism of educational policy. Labor market outcomes can be affected by a range of policy interventions. For example:

• An apparently unrelated policy, such as accession to the World Trade Organization (WTO), could have a significant impact on the returns to human capital development, for example by altering the composition of output and the demand for labor, and through protection of intellectual rights and the rewards to intellectual innovation.

• Reforms that improve access to safe drinking water and health care or reduce exposure to environmental pollution could contribute to improved health and greater capacity for learning and increased returns on public investment in education.

Physical Capital
Much of Russia's existing capital stock reflects the highly distorted economic incentives embodied in the Soviet system. Geographically, considerable investments have been undertaken in remote regions. Sectorally, investments have been made in industries in which Russia is unlikely ever to be internationally competitive. Technically, some of the capital stock either embodies technologies incompatible with international standards or is dominated by technology developed elsewhere. Indeed, some plants are "value-subtractors," and their decommissioning would actually contribute to economic output, especially if environmental degradation--or, alternatively, future cleanup costs--were assigned any value. Although the magnitude of this problem is subject to extensive debate, perhaps half of the Soviet-era capital stock is worthless under current market conditions.

Expenditures on infrastructure have trended downward, and as a consequence Russia's public infrastructure is in increasing disrepair. Financing problems reflect the underlying irrationality of the fee structure. The use of public infrastructure, including housing, and public utilities, such as water, priced at rates well below their actual cost, encourages over-usage and generates little revenue for maintenance and expansion. Maintenance of existing plants is hampered by Russia's inability to collect taxes and fees as well as by demonetization and the tendency for in-kind payment by industrial users. Introduction of more appropriate incentive structures without generating social upheaval is an ongoing political-economic problem. Reform is hampered by inadequate management capacity at the local level. More innovative financing schemes, such as quasi-equity investment, have not been introduced widely, in part because of investor skepticism about the protection of property rights. Increasing differentiation is occurring between those localities which are able to deliver services on a relatively reliable basis and those that cannot. This differentiation will presumably reinforce the trend toward concentrating economic activity in certain regions such as Moscow, St. Petersburg, and Nizhniy Novgorod.

Inadequate property rights discourage new investment at the aggregate level. Moreover, the aging of the population and the increase in the dependency ratio suggest that domestic public and private capital available to refinance new investments may decline over the next two decades. Lack of property rights also can distort investment incentives at the macroeconomic level. The lack of a real market for land hinders restructuring of existing investments and discourages new development, for example, the construction of new housing in regions that would naturally attract more residents and greater economic vitality.

Much of the useful capital stock and new investment are concentrated in extractive industries. In the oil and gas industries, the capital stock was designed primarily to facilitate domestic consumption, not export. In this regard, Russia faces two problems: first, the need to address bottlenecks in the export pipeline system, and second, the extraction of rents by intermediaries, such as Ukraine, which lie between Russia and the ultimate consumers of these exports. Russia will need to make significant investments over the next two decades to maintain the existing network, to relieve physical bottlenecks, and to develop alternative routes of export supply. Russian extractive industries are relatively well placed to do this for two reasons. First, they earn hard currency directly. Second, the import content of the pipeline maintenance and expansion is low and can be self-financed through ruble earnings domestically.

Ironically, the relative vitality of the extractive sector may pose problems for the manufacturing sector. The existence of a functioning extractive sector contributes to putting a floor under wage rates. As a consequence, real wages in Russia are unlikely to ever drop to, say, Indian subcontinent levels and thus discourage the development of highly labor-intensive manufacturing. But even the prospects of medium-tech manufacturing could be discouraged by the extractive sector due to what is known as "Dutch Disease"--the process whereby commodity booms tend to lead to exchange rate appreciations that price other economic activities out of world markets. It must be noted here, however, that the recent sharp increase in world oil prices and the consequent increase in Russia's hard-currency earnings have not caused the ruble to appreciate, perhaps because of offsetting capital flight.

Falling expenditures have led to a "hollowing out" of the Russian transportation system. Given the underlying economic irrationality of the geographic distribution of economic activity in the Soviet era, however, a certain withering away or redeployment of the existing capital stock may actually be desirable, at least from a market perspective. The Soviet-era transport system devoted excessive resources to servicing remote areas, and a decline in service to these areas is not necessarily an undesirable development--abstracting from geostrategic considerations. Like the extractive resource sector, much of the maintenance of the transportation network, largely rail, could be financed internally through tariffs and fees.

Improvement of the telecommunications infrastructure and the spread of the Internet in Russia could greatly facilitate the development of a market economy in Russia. Virtual connections across Russia's eleven time zones could create new connections previously impossible or impractical. The potential positive impact of the new technologies, however, will be mitigated if central or local authorities exercise too heavy a hand in attempting to control them.

Conclusions
A number of factors will influence the speed at which Russia converges with the West economically, if at all. Assuming that Russia's political development does not undercut continuing engagement with the West, it should be able to exploit what Alexander Gerschenkron called the "advantages of backwardness," or the ability to adopt technological innovations developed abroad without the costly and risky investments in discovery that innovation entails. This is related to the modern notion of income or productivity convergence--the tendency for relatively poor countries to experience more rapid increases in productivity and income than relatively rich countries.

In terms of innovation, the most obvious issue is the degree to which intellectual property rights (IPR) are protected, inasmuch as the rents conveyed to the innovator are a fundamental incentive for innovative activity. Moreover, the degree to which IPR are respected will affect the form and content of technological transfer that foreigners will be willing to undertake. In this regard, Russia's prospective accession to the WTO could affect how its IPR regime evolves, educational incentives, and its rate of productivity and income growth.

Since Russia is a "follower" country, technological diffusion is likely to be more important than innovation per se in boosting productivity. Efficient markets for labor and capital are critical in this regard, and Russia's markets for these factors are not very efficient. Progress in developing land markets and, hence, better housing markets could facilitate the movement of workers and improve the functioning of the labor market. Creating conditions conducive to foreign direct investment, especially outside the natural resources sector, could play a major role in encouraging technological diffusion. Again, accession to WTO is one development that could encourage such diffusion.

Finally, technological innovation and diffusion elsewhere in the world have been encouraged by the concentration of economic activities in particular locales, Silicon Valley being perhaps the most prominent example. The Soviet-era pattern of dispersing economic activities frustrated this process. Moreover, it endowed Russia with a number of one-factory towns that understandably form a locale of political opposition to restructuring. To a certain extent, Russia's economic activity is becoming concentrated. The regions around Moscow and St. Petersburg, in particular, have displayed increasing growth of new activities such as "finance."

A key issue for the next twenty years is how far Russia is willing to go to facilitate this process of concentrating economic activities. The process would be encouraged by the development of better housing markets and better provision of local services on the one hand and by the closure of noneconomic enterprises on the other. Such developments would spur the reallocation of resources by increasing the capacity of receiving areas while pushing resources out of sending areas. Conversely, continued subsidies for non-economic activities and suppression of factor markets would discourage mobility and the efficient allocation of resources.

As noted previously, such a reallocation would promote greater variability among sub-national jurisdictions in income levels and demographic characteristics, contributing to divergence between areas with concentrations of relatively young and rich populations and those with relatively old and poor populations. Such developments would presumably pose political issues with regard to equitable sharing of social welfare burdens, for example.

The existence of a large natural-resource-based extractive sector ensures that Russia will inevitably have the characteristics of a rent-seeking society in which considerable resources are devoted to allocating rents generated by the extractive sector. The state remains an essential mechanism for distributing wealth. The highly interventionist character of Soviet and post-Soviet economic policy and the relatively weak and underdeveloped nature of Russian political institutions reinforce the importance of rent-seeking over more socially productive forms of innovative or entrepreneurial activity.

The broad issue of the state's relationship to the private sector and issues such as transparency and corruption are fundamental to Russia's development over the next twenty years. Lack of progress in establishing a more rules-based economic system would discourage the development of an indigenous entrepreneurial class. This, in turn, would slow the rate of innovation and diffusion internally and forestall the possibility of exploiting emigre technological assets or engineering a reverse brain drain.

Likewise, ill-gotten gains on the one hand and concerns about expropriation of legitimately accumulated wealth on the other contribute to capital flight. Regularization of economic relations in Russia would reduce incentives for capital flight and indeed could encourage repatriation of capital currently invested abroad. Were this to occur, it would create greater domestic capacity to finance infrastructure investments. Ironically, the elimination of capital flight could contribute to "Dutch Disease" by encouraging ruble appreciation and making the exchange rate movements more susceptible to terms of trade shocks. This could actually present an additional challenge to Russia's industrial sector.

John Haaga
Population Reference Bureau

The Predictive Value of Demographics

Russian Demographic Trends and Their Implications
One needs to distinguish between two questions when discussing the predictive value of demographics: 1) Can demographers forecast the size and composition of populations? and 2) Would knowing the demographic future help us know the social, economic, or political future?

Population Projections
Demographers are excessively modest about their abilities--the purists insist on the term "projections" rather than "forecasts." When they prepare a projection, they are working out the algebraic consequences of various possible combinations of birth, death, and net migration rates. If you want to test some other combination you consider more plausible, then you do the math--put in some other combination and see what happens. The key idea in projections is the "cohort components" method, which has been in common use since the 1930s: Take a base-year population with a known age/sex structure, apply a set of age-specific fertility and mortality rates to it, and move it forward through time to any arbitrary future year. (For most countries, migration is not a major component of population change.) Population growth rates are calculated after you have finished adding up the separate age categories in a year; you don't try to forecast growth rates directly. The schedule of age-specific fertility and mortality rates need not be constant into the future, but one typically assumes gradual changes--a continued decline of fertility at all ages, for example, or a slowdown in the rate of improvement of mortality.

The usual practice for those making the projections is to present high-, medium-, and low-variants, which differ in the assumptions on one key component of population change. The usual practice for those using the projections is to toss out the high and low ones and use the medium-variant as a set of point estimates, the most likely forecast. In a way they are acting correctly, since other variables (growth rates of GNP per capita, per capita emissions of carbon dioxide or whatever) are usually forecast with greater uncertainty, so it is more important to test alternate scenarios in which they, rather than the population projections, vary. But in another way, they are setting themselves up for false conclusions, particularly if they take the medium variant to mean "what will happen utterly spontaneously, as a force of nature, without any further policy intervention." The more proper interpretation of the medium variant in most cases is "what will happen if trends, including policy trends, continue"--no change in policy, rather than no policy.

There is not a lot of theory underlying the commonly used projections. Users of projections of the Russian population ought to be aware that for the two fundamental processes, fertility and mortality, recent Russian trends are outside the range of historical experience. The columns and columns of numbers printed out on the Russian Federation page of the biennial UN volumes are misleadingly precise, and the people who produce them are the first to warn us about that.

Fertility Trends
First, let's look at fertility. The total fertility rate (TFR) is a kind of hypothetical average of age-specific fertility rates--the average number of children a woman would have if she went through life subject to the fertility rates for each age that prevailed in this particular year. Replacement-level fertility, allowing for some deaths of children before they themselves reach average childbearing ages, is just above two.

Russia and the Baltic Republics, during the last decades of the Soviet Union, were following a European trend, dropping below replacement-level fertility by about 1970.

Until the release of the most recent set of biennial projections prepared by the United Nations, the medium variant projections for every country assumed that there is something especially attractive about replacement-level fertility--fertility rates would converge on 2.1 or so within a few decades, no matter where they were starting from. The 1998 projections, for the first time, allowed medium variant projections to stay below replacement level for an indefinite future, including Russia. This represents an acceptance of a proposition that most European demographers think is correct, that below-replacement fertility will continue in Russia for a long time to come and cannot be easily reversed by policy.

How low can the TFR get? The lowest recorded value for the period TFR in a sizable, "free-range" population was 0.8 children per woman in the former East Germany during 1992-95. This was plausibly attributed by Nicholas Eberstadt and others to a severe disruption of life after the fall of the Berlin Wall--young people traveled or scrambled for jobs or apartments during those years and did not have babies. But there is little indication of things getting back to normal, if by "normal" we mean replacement-level fertility. Nor is low fertility limited to populations that have undergone severe shocks to their systems. Period fertility rates below one child per woman have persisted in the Basque country in Spain and in much of Italy during the 1990s. The Baltic countries, and many countries in Eastern and Southeastern Europe, on both sides of the former Iron Curtain, have total fertility rates below 1.5, and these low rates have persisted for several years. Much of Western Europe and Scandinavia lives with total fertility rates well below replacement level: Sweden is unusual in having had a rebound of sorts during the 1990s. There is some discussion in the demographic literature of whether there is a minimum long-term fertility rate for a large-scale population. A TFR below 1 is consistent with perhaps a quarter of women remaining childless, voluntarily or involuntarily, but most people experiencing parenthood.

The difference between high, medium, and low projections of fertility lead to different estimates of the size of the Russian population in 2030, ranging from 126 million to 150 million (the 1995 estimate was 148 million). This looks like a broad range, especially when we consider that under all three scenarios the median age of the population in Russia will be over 40. (In other words, the majority of Russians who will be alive in 2030 have already been born.) But in terms of the average growth rate over the course of 35 years, it's quite a small difference--roughly half a percent per year.

Trends in Life Expectancy
Russia had nearly caught up to the West in life expectancy in the early 1960s; in fact, Russia had caught up to Japan, a remarkable achievement. During the early 1960s, life expectancy leveled off and then started to fall in Russia, while it improved dramatically in the United States and especially in Japan. The gap grew steadily, except for a brief reversal of Russia's decline in the mid-1980s, during the years of Gorbachev's strenuous antialcohol campaign.

Two things are important to note:

• The Soviet antialcohol campaign deserves more attention than it has gotten in the public health literature.

Can We Use Population Projections To Forecast Social Change?
Our second question concerns the use of population projections for issues more directly concerning most policymakers.