Russia's road to economic ruin

Russia’s road to economic ruin

After Russia invaded Ukraine in February, the Russian economy seemed destined to take a dive. International sanctions have threatened to strangle the economy, driving down the value of the ruble and Russian financial markets. Ordinary Russians seemed ready for deprivation.

More than eight months after the start of the war, this scenario has not materialized. Indeed, some data suggests the opposite is true, and the Russian economy is doing well. The ruble has strengthened against the dollar, and although Russian GDP has shrunk, the contraction may well be limited to less than 3% in 2022.

Look behind the subdued GDP and inflation contraction figures, however, and it becomes clear that the damage is in fact severe: Russia’s economy is destined for a long period of stagnation. The state was already intervening in the private sector before the war. This trend has only intensified and threatens to further stifle innovation and market efficiency. The only way to preserve the viability of the Russian economy is either through major reforms – which are not in sight – or through institutional disruption similar to that which occurred with the fall of the Soviet Union.

Sanctions are not missiles

The misunderstanding of what sanctions against Russia would accomplish may be partly explained by unrealistic expectations about what economic measures can do. Simply put, they are not the equivalent of a missile strike. Yes, in the long term, sanctions can weaken the economy and lower GDP. But in the short term, all one can reasonably hope for is a massive drop in Russian imports. It is natural for the ruble to strengthen rather than weaken as demand for dollars and euros falls. And since the money that would have been spent on imports is redirected to domestic production, GDP should actually rise rather than fall. The effect of sanctions on consumption and quality of life takes longer to be felt in the economy.

At the start of the war, in February and early March, the Russians rushed to buy dollars and euros to protect themselves against a possible fall in the ruble. Over the next eight months, as Russian losses in Ukraine increased, they bought even more. Normally, this would have caused a significant devaluation of the ruble because when people buy foreign currencies, the ruble goes down. However, because of the sanctions, companies that imported goods before the war stopped buying foreign currency to finance those imports. As a result, imports fell by 40% in the spring. One of the consequences was that the ruble strengthened against the dollar. In short, it is not that the sanctions did not work. On the contrary, their short-term effect on imports has been surprisingly strong. Such a drop in imports was not expected. If the Russian central bank had anticipated such a massive fall, it would not have introduced severe restrictions on dollar deposits in March to prevent a collapse in the value of the rouble.

Of course, the economic sanctions had other immediate effects. Limiting Russia’s access to microelectronics, chips and semiconductors has made the production of cars and planes nearly impossible. From March to August, Russian auto manufacturing fell 90%, and the fall in aircraft production was similar. The same applies to the production of weapons, which is naturally a top priority for the government. Expectations that new trade routes through China, Turkey and other countries not part of the sanctions regime would offset the loss of Western imports have proven wrong. Abnormally strong ruble is a signal that hijacked import channels are not working. If imports came to Russia through hidden channels, importers would have bought dollars, driving down the rouble. Without these essential imports, the long-term health of Russia’s high-tech industry is disastrous.

The Russian economy is doomed to a long period of stagnation.

Even more important than Western tech sanctions is the fact that Russia is undoubtedly entering a period where political cronies are consolidating their grip on the private sector. It took a long time to do. After the 2008 global financial crisis hit Russia harder than any other G20 country, Russian President Vladimir Putin essentially nationalized big business. In some cases he placed them under the direct control of the government; in other cases, it placed them under the supervision of state banks. To stay in the government’s good graces, these companies were expected to maintain a surplus of workers on their payroll. Even companies that remained private were essentially barred from laying off employees. This has provided economic security for the Russian people – at least for now – and this stability is an essential part of Putin’s pact with his constituents. But an economy in which companies cannot modernize, restructure and lay off employees to increase their profits will stagnate. Not surprisingly, Russia’s GDP growth from 2009 to 2021 has averaged 0.8% per year, which is lower than the period of the 1970s and 1980s before the collapse of the Soviet Union.

Even before the war, Russian companies faced regulations that deprived them of investment. High-tech industries such as energy, transportation, and communications—those that would have benefited the most from foreign technology and foreign investment—faced the greatest restrictions. To survive, companies operating in this space have been forced to maintain close ties with government officials and bureaucrats. In return, these government protectors ensured that these companies faced no competition. They have banned foreign investment, passed laws imposing heavy charges on foreigners doing business in Russia, and opened investigations against companies operating without government protection. The result was that government officials, military generals and high-ranking bureaucrats – many of whom were friends of Putin – became multi-millionaires. The standard of living of ordinary Russians, on the other hand, has not improved over the past decade.

Since the start of the war, the government has further tightened its grip on the private sector. Starting in March, the Kremlin introduced laws and regulations that give the government the right to close businesses, dictate production decisions and set prices for manufactured goods. The massive mobilization of military recruits that began in September gives Putin another club to wield at Russian companies, because to keep their workforces, business leaders will have to negotiate with government officials to ensure their employees are exempt. of conscription.

Admittedly, the Russian economy has long operated under government control. But Putin’s most recent moves take that control to a new level. As economists Andrei Shleifer and Robert Vishny have argued, the only thing worse than corruption is decentralized corruption. It’s bad enough when a corrupt central government demands bribes; it’s even worse when several different government offices compete for donations. Indeed, the high growth rates of Putin’s first decade in power were partly due to the way he centralized power in the Kremlin, stifling competing predators such as oligarchs operating outside the fold of government. However, the emphasis on creating private armies and regional volunteer battalions for its war against Ukraine is creating new centers of power. This means that decentralized corruption will almost certainly resurface in Russia.

This could create a dynamic reminiscent of the 1990s, when Russian business owners relied on private security, mafia ties and corrupt officials to maintain control of newly privatized companies. Criminal gangs employing veterans of the Russian war in Afghanistan offered “protection” to the highest bidder or simply looted profitable businesses. The mercenary groups that Putin created to fight in Ukraine will play the same role in the future.

A long way to go

Russia could still score a victory in Ukraine. It’s unclear what victory would look like; perhaps the permanent occupation of a few ruined Ukrainian towns would be presented as a triumph. Alternatively, Russia could lose the war, an outcome that would make Putin more likely to lose power. A new reformist government could take over and withdraw its troops, consider reparations and negotiate a lifting of trade sanctions.

Regardless of the outcome, however, Russia will emerge from the war with its government wielding authority over the private sector to an extent unprecedented in the world except Cuba and North Korea. The Russian government will be omnipresent but at the same time not strong enough to protect businesses from mafia groups made up of demobilized soldiers armed with weapons acquired during the war. Particularly initially, they will target the most profitable companies, both nationally and locally.

For the Russian economy to grow, it will need not only major institutional reforms, but also the kind of clean slate that Russia found itself with in 1991. The collapse of the Soviet state rendered the institutions of that time obsolete. A long and painful process of building new institutions, increasing state capacity and reducing corruption followed, until Putin came to power and eventually dismantled market institutions and put set up its own patronage system. The lesson is grim: even if Putin loses power and a successor ushers in significant reforms, it will take at least a decade for Russia to return to the levels of private sector output and quality of life that the country enjoyed there. barely a year old. Such are the consequences of a disastrous and misguided war.


#Russias #road #economic #ruin

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