Prices without brakes: according to what scheme everything becomes more expensive in Russia

Someone from the audience immediately answered: 200 rubles, because that’s how much this bread and butter cost the society. But the lecturer did not agree: no, for all 300 rubles available to buyers. And he immediately complicated the task: “Now imagine that conflicts began to arise between them, and a boss was needed, which was the butter maker, freeing him from his previous duties while maintaining his earnings. And at the end of the month, having received 100 rubles each, they again go to the market, where there is no longer butter, but only bread. How much?” This time, the wiser listeners answered correctly: the same 300 rubles.

The lecturer also explained to us why the standard of living in the USSR is much lower than in the USA. “They,” he said, “for every two people who live by selling their goods or services to other people, there is one who lives off the taxes levied on these two – an official or military, police, anyone who works exclusively to the state. Pensioners are not included in this list – they get what they saved while they were working. In our country, this ratio is traditionally the opposite – one to two. True, these two also include pensioners, since pensions are paid from the budget.”

Later, I learned that in a market economy, both consumer prices and the processes of their change (called inflation if prices rise, or deflation if they fall) depend on the ratio of effective demand for goods and services to their supply. If the amount of money in the population grows faster than the amount of goods and services on the market, inflation is inevitable, which is called structural. Its “ban” is fraught with empty shelves and closed service points. When the market supply grows faster than consumer income, entrepreneurs, in order to avoid overstocking and downtime, reduce prices and arrange sales.

The second most important factor on which prices depend is the cost of production and circulation of goods, the provision of services. When the market or some part of it faces rising prices for raw materials, components, energy, transportation, borrowed money, labor, the final product rises in price, accumulating all additional costs. This is called cost-push inflation.

What happened in the consumer market with demand, supply and costs in recent years, what is happening now and what to expect?

To understand this, let’s first imagine, following the model mentioned above, but in accordance with Rosstat data on the composition of the population and the income of citizens and the budget, a society of 48 people, consisting of four groups. In the first, there are 18 workers, each monthly delivering one product to the market – a good or service with the same cost, consisting of two-thirds from wages and one-third from taxes and fees going to the public budget. In the second group there are 6 people, they perform responsibilities for managing and ensuring the safety of society, their work is paid from the budget at a price one third higher than the salary of workers from the first group. In the third there are 12 pensioners who receive from the budget amounts equal to a third of the salary in the first group. The fourth group also has 12 people, these are children and students who do not have their own income.

In this model, the ratio of the number of independent citizens earning money in the market and those who live off the budget, including pensioners, is one to one. This is twice as good as what we had in the late 1980s, but does not allow for comparison with the two-to-one ratio that we had then in the United States. According to the model, two-thirds of society’s budget income is provided by taxes and fees from the first group, another third comes from rent – payment for the use of natural resources owned by society, its size greatly depends on the global economic situation. Budget expenditures consist of three-quarters of payments to those who work for the state and pensioners, and the remaining quarter is distributed among other tasks of society, such as increasing pensions, developing infrastructure and human capital, and scientific research. Inflation is not included in the model, but it can be assessed as a consequence of changes in basic parameters.

This was approximately the case in 2016–2019. The consumer price index (CPI) was then quite moderate, averaging 104.3 percent, and reflected mainly cost-push inflation. And even when in 2020, to protect against the coronavirus pandemic, shopping and service centers, catering outlets, and industrial enterprises were massively closed—that is, the supply of goods and services decreased significantly—the CPI almost did not increase. Since at the same time the incomes of workers in quarantined organizations were reduced and large groups of the population were self-isolating, which no less significantly reduced demand.

But the next year, when restrictions began to be lifted and citizens’ first fear passed, their demand, which had been postponed during these difficulties, “shot” at the not yet fully strengthened supply, almost doubling the increase in consumer prices, to 8.4 percent.

Before we had time to really exhale after the pandemic, the SVO began, and already in March the CPI took off, having practically stopped since April at the level of 11–12 percent. Obviously, the March jump was caused by excessive demand, but if this were the only reason, in the future demand should have fallen below normal, dragging prices along with it. I see two reasons for the fact that this did not happen.

The first is on the supply side: our model shows that if, for the needs of the SVO, one of the 18 workers of the first group was transferred to the second group (I believe this is close to the truth), then the resulting decrease in the number of products on the market and the increase in the total income of the population should have led to to an increase in the average price of a product by 7 percent.

The second reason is on the demand side: over the past year, the average salary in Russia increased by 14 percent (in 2021 – by 6 percent). This exceeds the change in the physical volume of goods and services on the market so much that it can justify a more significant increase in prices than 12 percent. The fact that part of consumer income does not go to the market, but ends up in bank accounts and deposits, does not fundamentally change the picture, since banks pump these funds of some people into loans to other people, increasing demand in the consumer market.

In the first half of this year, price growth slowed down, but consumers are worried, and they have plenty of reasons to worry. The total increase in wages increases not only consumer demand, but also production costs. Other factors of cost inflation have also become more active—the cost of currency, credit, and logistics has risen sharply. And the growing deficit of the budget system is unlikely to allow it to support market supply on the same scale with government orders, subsidies and tax breaks.

This means that we should expect inflation to accelerate in the near future. And my biggest concern is how families with one or two working adults dependent on multiple children will cope, especially if those adults have low-paying jobs.

Such families tend to be among the 10 percent of Russian citizens with the lowest incomes. According to Rosstat data for 2021, this part of the population consumes one and a half times less meat, fish, dairy products and vegetables, and two times less fruit, than citizens with average incomes for the country. It is unlikely that average-income citizens overeat much, which means that those at the very bottom of the income line are undernourished, and some are starving.

Of course, price increases, especially for products in the first price range, the cheapest, will be restrained not only by a shortage of funds among consumers, but also by the authorities and retail chains. However, both of them understand that empty shelves are worse than high prices, and if it comes to this, the forgotten black market will be revived with even higher prices. Therefore, they will turn a blind eye not only to the already familiar grain inflation (such as “nine eggs” instead of ten), but also to manufacturers restraining the growth of their costs by reducing the cost of raw materials, technologies, and packaging in order to maintain the price of the product. Considering the moratorium on government supervision in the consumer market established a year and a half ago, this can be done with almost impunity, so don’t be surprised if you experience a new taste for familiar products or get a stomach upset. And don’t complain anywhere – it’s unlikely that anyone will be able to help you; it’s better to look for products and manufacturers that you can still trust.