May 1, 2006

Invest in China?
Invest in Russia!
by
Andrea Crandall

U.S. investors shy away from investing in “undemocratic” Russia, and pour money into authoritarian China. In fact, they should be as bullish about Russia as they are about China, given that the average Russian consumer spends four times as much as his Chinese counterpart, and his income is growing faster. American businesses are chasing the hope of future Chinese sales, while Russians are buying today. This anomalous neglect of Russian markets hurts their bottom line.

In gross domestic product terms (GDP), the Chinese economy is three times larger than Russia’s. China’s GDP is growing faster too, 9.8% in 2005 compared to 6.4% in Russia. (The U.S. economy grew 3.5%.)

However, US firms invest abroad to profit from new customers overseas, not to raise GDP levels. Customers buy more when GDP growth finds its way to their pockets through increased incomes. With this in mind, the Russian figures look more impressive. Russian per capita income in 2004 was US $ 3950, three times higher than the Chinese average of US $1280.

That larger Russian income is also growing faster. Over the past five years, the average Russian saw a 26% year-on-year growth in his income, whereas his Chinese counterpart saw a 10% rise. Over the past 15 years, Chinese incomes rose by the same amount every year, while in Russia year-on-year increases were 3% larger- setting a new high in 2004 of 36%.

Another carrot for investors is that Russians have the highest disposable income of any of Goldman Sachs’ promising “BRIC” (Brazil, Russia, India and China) nations. The percentage of Russian and Chinese income that is “disposable”-useable for spending or saving- is roughly the same. Although prices are about 15% higher in Russia, price-adjusted incomes in Russia are still 260% higher than in China.

A larger percentage of Russians can buy more, because Russia’s economic boom is shared more broadly across its population than China’s is. The richest tenth of China’s population buys one third of all goods consumed; in Russia the richest tenth buys about a fifth of all products. In fact, the typical personal spending of someone from the poorest fifth of Russian society is more than the spending of someone from the richest fifth of China’s. That means that if a product is aimed at shoppers with $1370 or more a year to spend, there are about an equal number of people in Russia and China who can safely afford to buy it.

Is Russia’s success just a “flash in the pan”? Maybe. But their long-term success is no less certain than China’s. Russia’s growth is driven by increasing oil prices and domestic demand, China’s growth by exports and foreign investment. These are both risky strategies. However, oil prices will continue to rise as long as there is instability in the Middle East and growing global demand- and both factors seem set to last. China’s growth drivers are less certain. In China’s largest export market, the U.S., there is mounting political backlash against the $200 billion trade deficit. American consumers have taken on irresponsible levels of debt, and are earning less than they used to (after inflation). How long will it be before Americans have neither the will, nor the money, to fuel “China’s Rise”?

Investors would also be wrong to view the Russian government as less trustworthy than the Chinese. Neither country has strong property rights enforcement; the Russian government arrests businessmen who meddle in politics and China fails to protect patent and copyrights. Both countries score low on Transparency International’s “corruption perceptions index” –Russia scores lower (2.4) than China (3.2) - but the sample bias is larger than the difference between these corruption perceptions. Beijing is no better for business than the Kremlin.

Yet, the U.S. isn’t scrambling to win Russian market share. Since 1998, trends in U.S. foreign direct investment (FDI) in Russia show that we are falling behind. U.S. FDI in Russia is one seventh of our FDI in China- for the six European members of the G7 (seven richest) countries that fraction is one-half to one-third. American investors aren’t running to catch up, either. U.S. average year-on-year FDI growth in Russia is amongst the lowest of the G7 countries. In contrast, American investment in China outdoes everyone except Japan, and reached a new high of $15 billion in 2004.

The Russian economy is growing phenomenally, but Americans are missing out. Hopes for Chinese markets tomorrow should not blind U.S. investors to real opportunities in Russia today. Investors should let performance, not prejudice, inform their decision.

Andrea Crandall is a Research Associate at the Council of Foreign Relations
She can be contacted at: alcrand@gmail.com