Thanks to Russia’s shift to a war economy, the country’s gross domestic product is growing, and its unemployment rate is at an all-time low. But the future is far less rosy due to a number of unaddressed economic weaknesses.
A summer stroll at the entrance to Red Square. Muscovites are feeling few of the war’s effects, and workers are even benefiting from higher real wages.
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In June of this year, a news release issued by the U.S. Treasury Department offered a confident headline about its Russia policy. «Treasury takes sweeping aim at foundational financial infrastructure,» it stated. Over 300 new sanctions had been issued, it noted. These included measures to prevent Russia’s arms and war industries from being able to finance themselves with the help of the two largest Russian state banks and the Moscow Stock Exchange. Since that time, the EU has adopted its 14th package of sanctions against Russia.
The scope of the economic restrictions imposed on Russia by Western countries has reached unprecedented proportions. Switzerland has also supported most of the EU sanctions.
Flourishing war industry
However, this avalanche of sanctions has failed to achieve the goal of making it impossible for Russia to finance and continue its war against Ukraine. If official Russian statistics are to be believed (and in fact there is little to suggest that they are broadly falsified), Russia’s economy has recovered quickly after a minor slump at the outbreak of the war, and is now growing faster than before.
According to the Finnish central bank’s Institute for Emerging Economies, the seasonally adjusted annual growth rate of Russia’s gross domestic product in the first quarter of 2024 was 5.4%, while overall investment rose by 14.5%. The unemployment rate has fallen to 2.6% – its lowest level since the global financial crisis.
Does this mean the Western sanctions have had no effect?
That would be a premature conclusion. Behind Russia’s economic boom lies the country’s structural transformation into a war economy. In addition, major construction investments are being made in transportation infrastructure so that Russian oil and gas can be sold more easily to Asia instead of Europe.
A comparison of the development of war-related sectors (armaments, metal processing, production of electronic and optical equipment, transportation) with Russia’s other industries shows the extent to which the war in Ukraine is changing Russia’s economy. These other sectors are growing very slowly. According to a new publication by the Center for Economic Policy Research, a London-based economics-focused think tank, production volumes within the war-related industrial sector have increased by around 60% since the outbreak of the war, and have more than doubled since 2019.
Like in the U.S. during World War II
This growth is being driven by enormous state expenditures and investments intended to bolster Russia’s war economy. According to the CEPR study, the Russian government expects spending to grow by 13% this year, with military expenditure increasing (further) by almost 70%. This latter category will then account for almost a third of the state budget.
However, the Russian state has not been forced to issue war bonds, as the United States did during World War II. Thanks in part to the high price of oil, Russia was able to sell goods worth $240 billion abroad in the first seven months of 2024. These were primarily oil and natural gas, three-quarters of which went to Asia. This means that despite Western sanctions, Russia is so successful that it continues to generate trade surpluses.
The fact that Russia’s economy is currently booming is thus thanks to the war economy, which is running at full speed. Because many defense companies are located in otherwise structurally weak regions such as the Urals, unemployment rates there have also fallen to a record low level.
In combination with the high pay levels provided to soldiers from these regions, this has increased purchasing power. The inflation rate is rising again as a result, and is currently deemed likely to exceed 9%. Russia’s central bank recently raised its benchmark interest rate to 18% as a result. However, on average, wages have risen faster than prices in recent years. This means that many working Russians can in principle afford even more than they could before Russia’s invasion of Ukraine. In the big cities of Moscow and St. Petersburg, the war feels very far away. Residents who refrain from making political statements in public, and who are not subject to repression for other reasons, can thus spend money in cafes and restaurants as they enjoy the summer.
So is something similar to what happened in the United States during World War II happening to Russia as a result of its invasion of Ukraine? Unlike Europe itself, America for the most part was not directly damaged in that war. The U.S. was still suffering from the effects of the Great Depression at that time. However, the entry into World War II and the shift to a war economy, in which the government-directed needs of the military took priority, led to an increase in GDP by more than half between 1939 and 1945. The country’s unemployment rate fell from 14.6% to 1.9%, according to a publication by the Economic History Association. With an innovative industrial sector centered around the defense industry, the U.S. ultimately emerged from the world war stronger than before.
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Dangerous development, with bleak prospects
However, it is unlikely that the devastating war in Ukraine will strengthen Russia similarly over the medium term, for a number of reasons:
- Reversion to a state-directed planned economy: The shift to a war economy has not happened on its own. It is certainly no coincidence that Kremlin ruler Vladimir Putin recently appointed Andrei Belousov, an economic planner who received his training in the days of the Soviet Union, as his new defense minister. The policy of tanks instead of tractors will cost Russia dearly in the medium term. To be sure, the country has not yet been fully militarized, and consumer goods are not yet being rationed. But the private sector, which is already struggling in Russia, is being squeezed out even more, and the influence of the corrupt bureaucracy is continuing to grow.
- Little import substitution: Russia’s economy is based strongly on the export of raw materials, and is consequently heavily reliant on Western technology. The sanctions are being strongly felt in this area. Attempts to replace Western technology with domestic products have not been very successful, as a new study shows. Russia has continued to import Western products by circumventing the sanctions, or in some cases is replacing them with Asian substitutes. But the country remains isolated.
- Low levels of innovative capacity: In the United States, a major military-industrial complex geared toward innovation emerged under the wartime economy of World War II. This subsequently spurred technological breakthroughs in the civilian sector, even later in peacetime. Russia’s military machinery, on the other hand, is not very innovative. Moreover, unlike in the United States, it is not geared toward the development of products that can be (energy-) efficiently used in civilian operations. The achievements of the Soviet car and aircraft manufacturers are long past. To this day, Russia has not managed to build a competitive civilian aircraft sector.
- Lack of innovative young people: Russia’s birthrate in the years following the collapse of the Soviet Union was particularly low. Tens of thousands of soldiers are now dying as a result of the Russian war of aggression in Ukraine, and hundreds of thousands of the most capable young men and women have fled the country. After the war, Russia’s lack of innovative young people will be even more dire than before.
- Squandered national welfare fund: Russia’s economy was and is heavily dependent on the export of fossil fuels. The quantity of such resources is ultimately limited. Moreover, international climate policies mean to replace such fuels with more sustainable energy sources. To allow future generations to share in the benefits of today’s raw materials wealth, Russia therefore created a national welfare fund and has invested revenues from the export of raw materials in it. However, this is now being used to finance the war, and will soon be exhausted without any sign that the civilian economy is becoming less dependent on commodity sales.
Unfortunately, neither the strong economic ties that existed between Russia and Europe before the war, nor the extensive economic sanctions imposed by the West, have been able to prevent Russia from waging its classic war of annihilation and attrition in Ukraine. Significantly more pressure on Putin’s team would probably arise only if Russia’s commodity revenues collapsed.
This does not mean that Western sanctions have proved wholly ineffective. They have made it difficult for Russia to access Western markets and Western technology. They are weakening its private-sector economy, and have made the country unilaterally dependent on China. Without a radical turnaround, the country’s future prospects will become increasingly bleak. Even if it seems that the economy is doing well today, Russia is using up its limited resources, and is repeating the old mistakes that once led to the collapse of the Soviet Union. Economically and technologically, the West remains far superior to Russia.
To exploit these advantages effectively, the West would simply have to gather the courage to carry out a targeted and coordinated economic war of attrition, as it once did under the leadership of U.S. President Ronald Reagan.
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