Cheapest Labor Since Tsars Ruled Russia a Draw for Samsung, Ikea

Truck at Russian Border Crossing

(Bloomberg – – Olga Tanas, Ilya Khrennikov – November 16, 2016)

Made in Russia and coming soon to a store shelf near you: washing machines, chewing gum and possibly much else.

A combination of the country’s worst currency crisis since 1998 and an unprecedented slide in real wages for most of the past two years has resulted in salaries that have become “broadly competitive” with China’s for the first time since the tsarist era ended a century ago, according to Renaissance Capital. In dollar terms, Russian wages last year fell to almost half the level in former members of the Eastern bloc such as the Czech Republic, the Moscow-based Higher School of Economics estimates.

That has companies from South Korea’s Samsung Electronics Co. to U.S. candy maker Mars Inc. flocking in search of cheaper labor costs. Data published on Wednesday showed a decline in industrial output moderated more than forecast by economists, taking its 10-month growth to 0.3 percent from a year earlier. The Economy Ministry projects further improvement will bring the full-year increase in production to 0.4 percent after a contraction of 3.4 percent in 2015.

“This is a strong statement that we can do something really competitive from Russia,” said Magnus Benon, head of purchasing operations in Russia for Ikea, the world’s biggest furniture retailer which started exporting upholstery products to Scandinavia and metal beds to China. “Russian suppliers are competitive today mainly because of the currency situation. I don’t think this is temporary.”

In one swoop, Russia is cracking the challenges accumulated over years of ruble appreciation and wage increases outstripping gains in productivity. While still a long way from contesting China’s status as the world’s factory, the mantle of a regional production hub is within reach.

‘Region’s Factory’

“It won’t be an exaggeration to say that Russia may become the region’s factory,” said Yaroslav Lissovolik, chief economist at the Eurasian Development Bank. “The goal of our manufacturers in Russia is to create alliances with foreign companies, to become part of regional and global chains of added value and thus to increase not only the country’s competitive potential, but also its export potential.”

The currency advantage can’t fully make up for many of the drawbacks that have long hobbled Russia, from the weakness of institutions to a poor investment climate. The bribery charges leveled on Tuesday against Economy Minister Alexei Ulyukayev, who’s since been dismissed from the post, are a reminder of the risks in a country that ranked 119th on Transparency International’s annual Corruption Perceptions index, released in January, behind Pakistan and Tanzania.
Russia’s property rights and the prevalence of foreign ownership were rated below the 120th spot among 138 nations in the World Economic Forum’s latest Global Competitiveness Report.

Taking Advantage

“In order for firms to capitalize on their current relative price advantage in international markets they would need to expand and change their output capacity and invest in both their products and production processes,” the World Bank said in a report on Russia’s export competitiveness in April.

Even so, with wages booming across much of eastern Europe, Russia looks increasingly appealing to companies like Samsung, which in September started exporting washing machines from its Russian factory to 20 European countries. Mars-owned Wrigley began production of its new Juicy Fruit chewing gum at a facility in St. Petersburg, with several markets a possible destination.

The reversal in fortunes for labor costs has largely hinged on the ruble, which is down almost 40 percent in the past two years against the dollar after the collapse in oil prices. Despite gains in the Russian currency’s real effective exchange rate, measured against the country’s major trading partners while stripping out the effects of inflation, it remains about 30 percent below its peak level in June 2013.

Suddenly Competitive

The jolt to wages has brought them not only below the level in other major emerging economies like Brazil as well as Russia’s peers in eastern Europe. At $558 last year, the average salary in Russia has dropped by almost 30 percent since 2011, taking it close to incomes in fellow ex-Soviet republics like Kazakhstan, according to the Higher School of Economics.

As lower commodity prices erode the share of energy in Russian exports, the proportion of other products — from food to machinery — is rising, according to the Economy Ministry. The question remains how far the seesaw of wages and the exchange rate can take Russia.

Surveys of the country’s manufacturing industry by IHS Markit have found that new business from foreign clients has declined every month since September 2013. For companies like Volkswagen AG, locally produced goods “aren’t yet globally competitive” despite a weaker ruble, said Natalia Kostyukovich, spokeswoman for the German carmaker’s Russian unit.

“Time and investment are necessary for exports of Russian-manufactured products to become a trend,” said Oleg Kouzmin, a former central bank adviser who’s now chief economist for Russia at Renaissance Capital in Moscow. “But there are grounds for Russia to carve out a niche in exports to Europe.”

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