Wells Benjamin
Introduction
The Russian proverb “A miser pays twice” references the often unexpected costs that arise from taking the cheaper route. Vladimir Putin himself has frequently used the proverb in official media releases, but many of the macroeconomic decisions made by the Russian state in the past two years have ignored this time-tested advice. While the Kremlin's targeted stimulus policy has bought Russia time, the shortsighted nature of decision-making has produced long-term economic instability that will be paid for in the future. Statistics released by the Russian Ministry of Finance paint a picture of steady economic growth despite the war in Ukraine and widespread economic sanctions imposed by Western nations. Russia has maintained a steady GDP growth of 3.6% in 2023, and this rate is expected to continue in 2024. While many in the West expected a quick collapse of the Russian economy due to sanctions and the loss of the European market for Russian hydrocarbons, Russia has seemed to remain resilient. Some of this resilience is due to the evasion of sanctions, where intermediary economies friendly to Russia act as middlemen between Western exporters. For example, the export of German goods to Kyrgyzstan has increased by 949% over the course of a year, which serves as a notable example of this practice. Decisions made in the Kremlin provide the other piece of the puzzle. The initial economic shock brought on by the cost of the invasion was dampened by monetary policy that raised interest rates; however, over the past two years, larger cracks have begun to emerge in the Russian economy.
The Core Issues: Inflation & Labor
Head of the Russian Central Bank, Elvira Nabiullina, describes Russia's attempts to preserve a strong economy despite deteriorating international standing and heavy costs associated with the war as a speeding car: “It can go, it might even be quick, but not for long.” Nabiullina’s statement points towards the nature of the war economy constructed by Putin’s regime, which has used high spending in the defense sector financed by oil revenue to stimulate the market artificially. Principal to the current state of the Russian economy, the Central Bank of Russia has forecasted an inflation rate of 6.5-7%. Inflation is expected to continue increasing over 2025 and 2026, a factor that is primarily driven by extremely high levels of government expenditure necessary to fund the war in Ukraine. The Russian Central Bank and the Kremlin seem to be at odds over monetary policy, with Putin’s ambition extending far beyond his means. It appears as if Putin has decided to make bold decisions and worry about the economic consequences later, much to the chagrin of Russian economists. While inflation is a looming pressure, unemployment is a major near-term problem for Russia, which compounds economic instability.
According to statistics released by the Institute of Economics of the Russian Academy, Russia currently faces a massive labor shortage of 4.8 million workers, affecting every sector of the economy. The shortage may come as a surprise when contrasted against a meager unemployment rate of 2.9%, which is lower than the current U.S. rate of 4.2%. Additionally, real wages in Russia have increased by 12.9% in a year; however, this is primarily concentrated in areas that have benefited from the defense industry. It may seem counterintuitive at first for there to be a shortage of workers in a country with increasing wages and low unemployment, but these metrics have changed due to the increased demand for labor forced by a shortage. In the 2023 fiscal year, 91% of firms in Russia reported a shortage of personnel. Russia is also uniquely facing a labor shortage across both blue and white-collar domains. Many low-skilled young men who would normally fill industries such as manufacturing or construction have been sent to fight or have fled out of fear. It is difficult to estimate the exact figures for the number of people who have left Russia following the 2022 invasion, but most figures agree that the number is over one million. Fleeing the draft requires financial resources only available to the upper and middle classes- the same demographics that primarily fill higher-skill positions like in the information technology field. The most significant cause of the personnel issue threatening the Russian industry is the lack of automation compared to Chinese and Western firms, which generates a higher demand for labor. It is unlikely that Russia will be able to increase the amount of capital within its firms, as government spending is focused on winning in Ukraine, and foreign direct investment has largely disappeared compared to pre-war levels.
Defense Spending
Russia has maintained a relatively stable economy due to colossal levels of stimulus given to its defense industry, with many outlets reporting higher than pre-war levels of arms production. While the Russian defense industrial complex has remained capable of producing a level of output needed to engage in a major conflict, the means taken by Putin to do so are indicative of the type of policy decisions that threaten long-term growth. According to the 2024 budget, Russian expenditure on defense will account for 40% of the total budget, the highest level ever seen in the Russian Federation. In order to fund this massive increase, Putin has redirected money reserved for social programs to the arms industry, with funding for healthcare, schools, and infrastructure all decreasing. The practice of using state savings to invest heavily in defense production is inherently unsustainable, as although it may work to boost production in the short term, such an approach will lead to adverse effects in the future. It is particularly important to note that the defense industry is unlike other sectors in that the finished goods produced have a minimal positive impact on the economy. For instance, while an automobile manufacturer produces a product that will last for years and enable an individual a greater degree of mobility, once a missile is fired, it is incapable of further contributing to an economy.
Conclusion
The pre-war Russian economy relied heavily on selling hydrocarbons to European markets, but the implementation of sanctions has forced a reduction of prices and a shift of markets towards Asian consumers, such as India and China. This loss of revenue, combined with a decreased tax base, has led to a need for Russia to lean on savings built up by years of lucrative gas sales to the West. While Putin has successfully avoided a catastrophic shock brought on by Western sanctions, his methods of doing so have put the future of the Russian economy in its totality at stake. Rampant unemployment, rising inflation, and a reduction in government expenditure on GDP-boosting programs will potentially return to cause lasting damage. While some could argue that Russia will offset these issues through an increased partnership with China, the unequal nature of this partnership creates other issues related to a loss of sovereignty and is not a panacea for Russia’s economic woes. Chinese hydrocarbon demand and cheap manufactured goods are undoubtedly helpful in maintaining short-term economic stability, but the Chinese market is not capable of generating the same level of revenue as Europe was able to. As Russian citizens grow less supportive of the “Special military operation,” chances of domestic political blowback for the war increase significantly. While it is unlikely that these overarching macroeconomic concerns will determine the outcome of the war in Ukraine, an overheating economy will serve as a powerful limiting factor for how long Russia can maintain its offensive pace. As Russia faces an unparalleled demographic crisis exacerbated by mobilization, severe material losses due to the war, and political instability, potential economic failures will lead to a further loss of credibility for Putin’s regime. A miser pays twice, and by trying to buy a war economy on the cheap, Putin has ensured that a second bill will be delivered.
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