Is Natural Resource-Rich Russia Suffering From Dutch Disease? Cointegration Analyses with Structural Break

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1 Is Naural Resource-Rich Russia Suffering From Duch Disease? Coinegraion Analyses wih Srucural Break Fikre DÜLGER a Kenan LOPCU b* Almıla BURGAÇ a Esra BALLI a Duch Disease phenomenon is defined as he discovery of new resources and/or an increase in he price of naural resources which causes he appreciaion of he real exchange rae and leads o he decline of manufacuring and ulimaely o increases in service prices. According o he UNDP, Russia repor 009, increases in energy income have resuled in he decline of oher secors of he Russian economy. Furhermore, he repor claims ha hese developmens may rigger a recession in Russia in he fuure. In fac, in recen years he Russian economy has exhibied some ypical sympoms of Duch Disease along wih increases in oil prices accompanied by a reducion in he share of manufacuring oupu and an increase in service prices. Using Gregory Hansen and Arai-Kurozumi coinegraion mehods, our resuls indicae ha Russia migh in fac be suffering from Duch Disease in he pos Sovie Union-era. Keywords: Duch Disease, Russian Economy, Coinegraion, Srucural Break JEL classificaion: F4; F3; C a Deparmen of Economics, Çukurova Universiy, Balcalı, Adana 0330, urkey b Deparmen of Economerics, Çukurova Universiy, Balcalı, Adana 0330, urkey * Corresponding auhor. klopcu@cu.edu.r 0

2 . Inroducion Naural resource-poor economies such as Japan, Swizerland and Singapore ouperform naural resource-rich counries such as Mexico, Venezuela, and Russia. Sachs and Warner (995) showed ha 97 developing counries wih a high raio of naural resource expors o GDP end o have low growh raes for he period of Krugman (987) indicaed ha he discovery of radable naural resources, such as oil in a counry leads o a real appreciaion of is exchange rae and hus crowds ou oher radable secors of he counry. A case in poin in his regard is he Neherlands, where he compeiiveness of Duch manufacuring was clearly hur by naural gas discoveries. he case is no limied o he Neherlands bu suppored by a number of oher examples. Ineresingly, in convenional rade models his would no be regarded as a problem, and counries would simply be advised o specialize in areas in which hey have a comparaive advanage. In pracice, however, he conracion of a counry s manufacuring secor following naural resource discoveries causes a grea deal of concern because of he fear ha he los manufacuring secors will no come back when he naural resources run ou (Krugman, 987). Corden (984) noed ha he concep of Duch Disease is inroduced for he firs ime in an aricle published in he Economis on November 6 h 977. Corden and Neary (98) and Corden (984) formed he firs Duch Disease model. he core model consiss of hree secors, namely he Booming Secor (B), he Lagging (radable) Secor (L) and he Non- radable Secor (N). he Booming and Lagging secors produce radable goods. Each secor uses labor and a facor specific o ha secor o produce oupu, and labor mobiliy beween all hree secors equalizes he wage rae. According o he model, a boom in secor B increases he aggregae income in ha secor for hree possible reasons: (i) because of echnical progress which leads o a posiive shif in he producion funcion or (ii) a discovery of new resources or (iii) a rise in naural resource prices. Corden and Neary (98) showed ha a naural resource boom affecs he economy hrough boh he spending effec and he resource movemen effec. he resource movemen effec can be explained as a resul of he boom. When a boom happens in secor B, he marginal produc of labor increases in ha secor and labor moves from secors L and N o he Booming Secor, pushing wages up and shrinking he level of oupu in secors L and N causing a direc de-indusrializaion. When facory owners or governmen spend he exra income earned in Secor B, on he condiion ha he income elasiciy for N is posiive, he real exchange rae appreciaes (he spending effec). Meanwhile, in addiion o he spending effec, a decrease in oupu in secor N leads o a furher increase in prices in ha secor and causes addiional movemen of labor ou of L ino

3 N, reinforcing he de-indusrializaion furher. his laer process is known as indirec deindusrializaion. hus, he combinaion of hese effecs can cause a real exchange rae appreciaion, a relaive de-indusrializaion and a real wage growh. here is a grea deal of lieraure on Duch Disease, including a number of sudies for he Russian case. Mos sudies agree ha he Russian economy is affeced by he rapid changes in he price of oil. A number of sudies show ha an increase in oil price appreciaes he ruble (Spaafora and Savrev, 003; Rauava, 004; Sosunov and Zamulin, 006; Habib and Kalamova, 007; Oomes and Kalcheva, 007; Algieri, 0; Mohammadi and Jahan- Parvar, 0). Éger (005) shows ha he real exchange rae appreciaion sympom of Duch Disease holds for Russia as he ruble appreciaes boh agains he Euro and Dollar. abaa (0) argues ha Russia s overdependence on oil and gas expors affecs he Russian economy, however, he sympoms of he Duch disease are no acually exreme. Algieri (0) found ha Russia exhibis he sympoms of Duch Disease, including real effecive exchange rae appreciaion and relaive de-indusrializaion. Unied Naions Developmen Program (UNDP) Russia Repor (009) warned ha Russia may suffer from Duch Disease in he near fuure. Specifically, he repor indicaed ha he budge, invesmens and inernaional rade for Russia are all heavily depended on world energy markes, making he Russian economy vulnerable o global crises and affecing is long-erm economic growh. Likewise, he former Russian finance miniser Aleksey Kudrin indicaed in a speech ha Russia is suffering from Duch Disease (Kudrin, 0). Dobrynskaya and urkisch (00) argued ha alhough Russia had some sympoms of Duch Disease, here was no sign of deindusrializaion. Ollus and Barisiz (007), Oomes and Kalcheva (007) indicaed ha he Russian economy appears o have sympoms of Duch Disease. However, hey emphasize ha de-indusrializaion could have been driven no only by Duch Disease bu oher facors as well. Ahrend, Rosa and ompson (007) found ha he resuls are ambiguous wheher Duch Disease is apparen for Russia. o sum up, he lieraure on Duch Disease dealing wih Russia offers overwhelming evidence ha Russia suffers a leas one of he sympoms of Duch Disease-real exchange rae appreciaion, increases in service prices and deindusrializaion. his sudy invesigaes he real exchange rae appreciaion and de-indusrializaion sympoms of he Duch Disease for energy resource-rich Russia using coinegraion echniques wih a srucural change over he period 995:Q o 0:Q. he paper improves upon he exising empirical sudies on he Russian Duch Disease boh in erms of employing a new daase, as well as allowing a srucural change ha migh have occurred over he

4 sample period. A boom in he Russian case corresponds o an increase in he price of oil. Hence, we consider he energy secor as he Booming Secor, he manufacuring secor as he Lagging Secor and he service secor as he non-radable secor. Our findings indicae ha Russia does indeed illusrae he sympoms of Duch Disease. he res of he paper is organized as follows: Secion wo presens empirical sraegy and daa; secion hree discusses he empirical findings; and secion four concludes.. Empirical Sraegy and Daa o analyze he sympoms of Duch Disease for Russia, following Algieri (0), we use wo main models wih he relaive producion of manufacuring o services and he real effecive exchange rae as dependen variables. Sympmom I : ( yman / yserv ) f ( prod, poil ) Sympmom II : reer f ( prod, poil ) Where (yman/yserv) sands for he relaive producion in manufacuring secor o service secor, prod is he relaive produciviy of manufacuring o services, poil denoes he price of oil and reer shows he real effecive exchange rae. Sympom I and Sympom II represen deindusrializaion and he real exchange rae appreciaion due o Duch Disease, respecively. he sign for prod is expeced o be posiive in he firs equaion, because when he relaive produciviy grows, he manufacuring oupu grows as well. he expeced sign of poil, on he oher hand, is negaive since an increase in poil leads o de-indusrializaion according o Duch Disease. Boh poil and prod are expeced o have posiive signs in he second equaion, as suggesed by he lieraure. he daa se covers he period from 995:Q o 0:Q. he dependen variables in our sudy are he relaive producion of manufacuring o services and he CPI based real effecive exchange rae. he relaive producion of manufacuring o services is compued by dividing he producion in he manufacuring secor o he producion in he service secor. he manufacuring and service secor series are obained from he Organizaion for Economic Co-operaion and Developmen (OECD) and Rossa. he real effecive exchange rae series is from he Inernaional Financial Saisics (IFS). We have used he price of oil and he relaive produciviy of manufacuring o services for Russia as independen variables. he price of oil is exraced from he Unied Saes Energy Informaion Adminisraion (EIA). Average labor produciviy is used as a proxy for produciviy. In order o compue he produciviy in he manufacuring and service secors, he oal oupu in each secor is divided 3

5 by he employmen level in ha secor. he relaive produciviy is defined as produciviy in he manufacuring secor divided by produciviy in he service secor. he oupu and employmen series are obained from he OECD, he Inernaional Labor Organizaion (ILO), he Russian-European Cenre for Economic Policy (RECEP) and he Rossa. All he secoral oupu and employmen series for Russia are seasonally adjused using X-, before he average produciviy for each sub-secor is calculaed. All variables are convered ino naural logarihm. An increase in he real effecive exchange rae corresponds o appreciaion of he Russian ruble. 3. Economeric Mehodology We sar by invesigaing he order of inegraion of he variables using he ADF (Dickey and Fuller, 98) and KPSS (Kwiakowski-Phillips-Schmid-Shin, 99) ess. We es he long-run relaionship beween variables using Gregory-Hansen (G-H) (996a, b) and Arai- Kurozumi (A-K) (007) coinegraion ess which allow for a srucural break. Gregory-Hansen (996a, b) provide a residual-based es wih one srucural change in he coinegraion relaionship a an unknown ime during he sample period. he srucural break is deermined endogenously. he null hypohesis is no coinegraion agains he alernaive hypohesis of coinegraion in he presence of a srucural break. he dummy variable ha indicaes he srucural change is defined as follows (Gregory Hansen, 996a, p.0-03): 0 if if.,.. Where he unknown parameer τ (0,) denoes he iming of he srucural change poin and [ ] denoes he ineger par. Gregory-Hansen (996a, b) developed four models for esing coinegraion under a srucural break. Level Shif y y, =,,. A level shif model allows only a change in he inercep. Μ presens he inercep before he shif and μ shows he change in he inercep a he ime of he shif. Level Shif wih rend y y, =,. he second model includes a ime rend and permis a break in he inercep as he previous model (level shif wih rend). 4

6 Regime Shif y y y, =,. In he hird model he srucural change allows he slope vecor o shif as well. his model is called he regime shif model. Μ and μ are as in he level shif model, denoes he coinegraion slope coefficiens before he regime change and he slope coefficiens afer he regime change. Regime and rend Shif (Gregory-Hansen, 996b) y y y, =,..,. denoes he change in In he fourh model, μ, and β denoe he inercep, slope coefficiens and rend coefficien, respecively, before he regime shif and μ, break. and β show he changes afer he In hese four models, dummy variable, φ τ, akes value (0,). Non-saionariy of he residuals under he null hypohesis is esed by he modified Phillips-Perron (PP) uni roo ess (Z and Z α ) and he ADF es saisic, using he smalles value of hese saisics across all possible break poins. * Z min Z ( ), * Z min Z ( ), ADF * min ADF( ). Arai-Kurozumi (007) provides residual-based ess for he null hypohesis of coinegraion wih a srucural break agains he alernaive of no coinegraion for he firs hree models of G-H. We modify he A-K framework in order o apply i o he level shif wih rend model of G-H (996b). Addiionally, o deal wih he simulaneiy bias, we use he dynamic OLS, adding he leads and lags of he firs differences of he regressors following A- K (007) and Kejriwal (008). Hence, we have he following modified models. Level Shif K ' ' ' * y y iy, i,...,. Level Shif wih rend ik K ' ' ' * y y iy, i,...,. ik 5

7 Regime Shif ' ' ' ' * y y y iy, i,..,. Regime and rend Shif K ik ' ' ' ' * y y y iy, i,..,. where π i is a parameer vecor for K I K. hese are regression models where he leads and lags of y are added o he G-H models. he esimaor for he break poin is obained by minimizing he sum of he squared residuals over all possible poins and is defined by ˆ min SSR ( ) Where, [, ], 0, and SSR () is he sum of squared residuals based on he break fracion. he es saisic for he null of coinegraion wih a srucural break, hen, is given by (Kejriwal, 008, p.4): and ~ V ( ˆ) S ( ˆ) * Where Ω is a consisen esimaion of he long run variance of, ˆ ( ˆ / ), ( ˆ) e ~ i ˆ i S and e ~ ˆ i K jk represen he residuals from he modified models above. he above es saisics are compared wih he criical values obained by simulaions using 00 seps and 500 replicaions. 4. Empirical Resuls able shows he ADF and KPSS uni roo ess. he ADF ess reveal ha none of he variables are saionary a he % significance level while he KPSS ess indicae ha all he variables are non-saionary a he 0% significance level. On he oher hand, all he variables are saionary in he firs differences according o all ADF and KPSS ess. Hence, we conclude ha all he variables are inegraed order of one, I (), a levels. 6

8 able presens he resuls of boh G-H (996 a, b) and A-K (007) coinegraion ess wih srucural break for Sympom I. According o he G-H coinegraion es resuls, for he level shif model he null of no coinegraion is rejeced a he 0% significance level by he ADF, Z α and a he % significance level by Z ess. he A-K es, on he oher hand, canno rejec he null of coinegraion wih srucural break a any significance level. For he level shif wih rend model, he null is no rejeced by he ADF and Z α ess, bu is rejeced by he Z, es a 0%. According o he A-K es, he null of coinegraion wih srucural break is rejeced a he 5% significance level bu no a %. he resuls for he regime shif and he regime and rend shif models indicae ha he null of no coinegraion is no rejeced by all 7

9 hree saisics using he G-H ess. However, he A-K es canno rejec he null of coinegraion for he regime shif model a any convenional significance level and rejecs i a only 0% for he regime and rend shif model. Overall, he resuls in able offer favorable evidence for coinegraion by he A-K ess and less so by he G-H ess. he las saemen is valid, especially for he regime shif and he regime and rend shif models. I is worh noing ha he endogenously deermined break daes wih significan coinegraion relaionships coincide wih he global economic crises of 008, according o boh ess, excep for he regime and rend shif model in he A-K es. he break dae in his model is 00:Q, in beween he 997 Asian, 998 Russian and 008 global economic crises. able 3 shows he resul of boh G-H (996 a, b) and A-K (007) one srucural break coinegraion ess for Sympom II. According o he resuls of he G-H ess, he null of no coinegraion is rejeced a leas by one of he Z, Z α or ADF ess a convenional significance levels, excep for he regime shif model. For he regime shif model, he GH ess provide no evidence of coinegraion a convenional levels. urning o he A-K ess, hey provide overwhelming evidence in favor of coinegraion for all models. Specifically, he null of coinegraion wih a srucural break canno be rejeced for all he models excep he regime shif model, even a he 0% level, and i is barely rejeced a he 0 % significance level for he regime shif model. he break poins deermined by he G-H and A-K coinegraion ess for Sympom II immediaely follow he Asian economic crisis of 997 and coincides wih he Russian economic crisis of

10 he esimaed coinegraion regressions wih srucural break for Sympom I are repored in able 4. For level shif and level shif wih rend models, he esimaed coefficiens for he G-H and A-K coinegraion regressions are very similar. Boh prod and poil have a priori expeced signs and he magniudes are nearly he same. he A-K coinegraion regression resuls for he regime shif model show ha a % increase in prod leads o a.38% and 0.73% increase in relaive producion of manufacuring o services before and afer he break dae, respecively. Poil is significan before he srucural break bu no afer he break, implying ha an increase in poil causes de-indusrializaion unil he break dae. For he regime and rend shif model, he sign of relaive produciviy is posiive in boh regimes. he coefficien for poil is no significan in he firs regime. Alhough, i becomes significan afer he regime change, he sign is posiive and hence is inconsisen wih Duch Disease in he second regime. he las model seems o fi daa less well han he oher models in comparison, since wo of he coefficiens are insignifican. Neverheless, all he oher hree models overall suppor he relaive de-indusrializaion sympom of Duch Disease for Russia. 9

11 Coinegraion regressions resuls for Sympom II of Duch Disease are repored in able 5. For he level shif and level shif wih rend models, again he esimaed resuls are similar. Prod is no significan in any of he cases considered while poil is posiive and significan, indicaing he appreciaion of he real effecive exchange rae, Sympom II of Duch Disease. For he regime shif and regime and rend shif models, prod coefficiens are all posiive and significan in all he cases in he firs regime, a resul consisen wih he convenional Balassa-Samuelson hypohesis. Alhough, he coefficiens coninue o be significan a some convenional level, hey all become negaive in he second regime. he A- K coinegraion regressions, on he oher hand, reveal ha he coefficiens for poil are posiive and significan only in he second regime, hence compaible wih Duch Disease. For he G-H coinegraion regression of he regime and rend shif model, meanwhile, he coefficiens for poil suppor Duch Disease in boh regimes. he rend coefficiens in he regime and rend shif model are all posiive and significan in boh he G-H and A-K coinegraion regressions wih magniudes circa 0.0. his indicaes he endency of he ruble o appreciae hrough-ou he sample period. o sum up, he resuls vary depending on he model and he mehod (G-H vs A-K) employed. Overall, however, hey provide considerable evidence ha Russia is indeed suffering from he Duch Disease. 0

12 5. Conclusion Given he span of he daase and he economeric echniques employed, he resuls show ha Russia appears o have sympoms of Duch Disease. hese resuls are consisen wih he lieraure cied earlier and he UNDP Russia Repor (009). If oil begins o run ou or he price of oil decreases, he manufacuring indusries may no recover quickly enough o compensae for he oil secor. hus, Russia may lose is compeiive posiion in manufacuring, and as a resul, a recession may be riggered in he near fuure. We acknowledge ha he de-indusrializaion process could have been driven by oher facors as suggesed by Dobrynskaya & urkisch (00) and Oomes & Kalcheva (007). hese auhors recognize ha de-indusrializaion and he real appreciaion of he ruble are boh sympoms of Duch Disease. However, increases in produciviy, an expanding domesic marke and he occurrence of new marke opporuniies afer he collapse of he Sovie Union could also cause hese indicaors. Fuure research is needed o scruinize he causes for he presence of hese sympoms of Duch Disease furher. References Ahrend, R., Rosa, D. and ompson, W. (007), Russian Manufacuring and he hrea of Duch Disease - A Comparison of Compeiiveness Developmens in Russian and Ukrainian Indusry, OECD Economics Deparmen Working Paper No Algieri, B., (0), he Duch Disease: evidences from Russia, Econ Change Resruc, 44, s Algieri, B., (0), Deerminans of he real effecive exchange rae in he Russian Federaion, he Journal of Inernaional rade & Economic Developmen, s. 5. Arai, Y., and E. Kurozumi, (007, esing for he Null Hypohesis of Coinegraion wih a Srucural Break, Economeric Reviews, 6, 6, s Balassa, B., (964), Purchasing Power Pariy Docrine: A Reappraisal, he Journal of Poliical Economy, 7, s Corden, W. M., (984), Booming Secor and Duch Disease Economics: Survey and Consolidaion, Oxford Economic Papers, 36, s Corden, W. M., and Neary, J. P., (98), Booming Secor and De-Indusrializaion in Small Open Economy, he Economic Journal, 9, s Dickey, D A. and Fuller, W. A., (98), Likelihood Raio Saics for Auoregressive ime Series wih a Uni Roo, Economerica, 49, s

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