When businesses make international investment decisions, the focus is often on assessing a country’s gross domestic product (GDP) per capita as a barometer for its market potential. The assumption is that there is a positive relationship between the two, as a country’s GDP per capita is used as a proxy for its wealth.
However, relying solely on GDP per capita as an indicator can be misleading and provide an incomplete picture of the geographical distribution of risks and opportunities.
To illustrate this, Dun & Bradstreet compared Russia with some of its regional peers in the Commonwealth of Independent States (CIS). GDP per capita in Russia, at just over $12,700 in 2014, is more than double the regional CIS average ($5,600). Russia’s GDP per capita is also higher than in Kazakhstan ($12,400), Azerbaijan ($7,900), and Ukraine ($3,000) — some of the largest economies in the region.
However, the results of the World Economic Forum’s recently published Global Competitiveness Report 2015-2016 (GCR) suggest that on a variety of other measures, Russia offers a less attractive business environment, with a number of factors that limit actual market potential.
For example, Russia compares poorly with many of its regional peers in terms of “public sector performance” — despite a significantly higher GDP per capita. “Public sector performance” is measured in the GCR in terms of an index that ranks 140 economies globally based on the following criteria: wastefulness of government spending, burden of government regulation, efficiency of the legal framework in settling disputes, efficiency of the legal framework in challenging regulations, and the transparency of government policy making.
These factors have a significant impact on the business environment and the potential gains that can be achieved in a particular market.
While GDP per capita in Russia is more than four times that in Ukraine and more than 10 times that in Kyrgyzstan, its GCR ranking for public sector performance falls within the same range as these countries (102 in Russia compared to 106 in Kyrgyzstan and 119 in Ukraine).
Meanwhile, the rankings suggest that other regional peers — all with GDP-per-capita levels below Russia (in some cases substantially so) — offer a significantly more business-friendly public sector. The burden of government regulation is considered to be a particularly problematic factor for businesses operating in Russia, as it is ranked 116th out of 140 economies — below all of its regional peers included in the GCR. Other problematic factors include corruption, tax rates, and access to financing.
Business analysts should be cautious and not just in relying too heavily on GDP per capita for gauging market potential, but also in making the intermediate assumption that GDP is a reliable proxy for wealth. For example, GDP per capita does not take into account income distribution.
Russia’s relatively high level of GDP per capita conceals the fact that most of the country’s wealth is concentrated in the hands of a very small share of the population. The Gini coefficient provides a measure of inequality, assigning countries a score between 0 and 100 (where 0 represents perfect equality and 100 signifies perfect inequality).
The latest data from the World Bank suggests that income inequality in Russia (with a Gini coefficient of 41.6) is substantially higher than in many other CIS countries, including Ukraine (24.6), Kazakhstan (26.4), and Kyrgyzstan (27.4). As income inequality has been found to have a negative relationship with market potential, this suggests that using GDP per capita as an indicator of Russia’s relative market potential could lead to an overestimation.
In summary, while approximating the wealth (and, by extension, the demand) of a population is important when assessing the relative attractiveness of a market, two factors should be kept in mind:
- GDP per capita is an imperfect measure of wealth. While a country may have a high level of GDP per capita, demand will be constrained if income inequality is high and the majority of the population has relatively low income.
- A number of other factors can have a significant impact on the business environment, and thus ultimately on the likely investment returns that are achieved in a particular market.
Jaspreet Sehmi is a Senior Economist in Dun & Bradstreet’s Macro Market Insight team. Based in Marlow/United Kingdom, she covers Eastern Europe and Central Asia. She has an MSc in Economics from University College London.