Putin’s 25 years at the helm have been little different to the Soviet era. He has again made Russia a military giant but an economic dwarf.
LONDON: Sanctions! What sanctions? You could almost hear the sneer coming from the Kremlin last Sunday as President Vladimir Putin signed off Russia’s new budget, which had been approved a few days earlier by lawmakers in both the State Duma and the Federation Council. Russia’s economy is booming and of the total budget of 42 trillion roubles ($397 billion), a gargantuan third has been allocated for national defence, up from 28% this year. The figure represents 6.5% of Russia’s GDP, the highest in the country’s post-Soviet history and a huge increase since 2021 when it was a modest 2.7%. By contrast India, the fastest growing major economy in the world, is currently spending about 2.5% on defence and the US 3.5.
Almost three years into his full-scale invasion of Ukraine Vladimir Putin, who decades ago lamented the collapse of the Soviet Union, is changing Russia’s economy to what is essentially a Soviet one, modified in part by market elements. The distinguished Russian commentator, Andrei Kolesnikov, describes Putin’s new economic model as “one shaped not only by the imperatives of his war in Ukraine, but also by decades of Soviet nostrums and delusional thinking.” The new model, he says, “combines state intervention, a dominant emphasis on the military-industrial complex, with a market economy in different areas, including parallel imports of various Western products to satisfy consumer demand.”
On the surface, the Kremlin can point to a degree of recent economic success. Russia’s debt-to-GDP ratio is less than 13%, while many European countries are creaking under the weight of their debt. The US, UK and France, for example, are recording debts of more than 100% of their GDP, while India’s is hovering around 82%. Inflation adjusted wages in Russia have increased dramatically in the past year by more than 9%, which means that most Russians are able to buy more and feel significantly better off. Among those who are especially “winning” from the current war are millions of Russians in blue-collar jobs. As in Soviet times, the war has been a financial boon for Russia’s military-industrial complex and related industries. The armed forces and their families, and all parts of the public sector connected with defence and security are also flourishing. Military plants, sitting almost idle a decade ago, are now working around the clock, such is the demand for their products. Some of the most in-demand wartime professions are milling machine operators, welders, weavers and garment workers. The wages of men and women working in these professions have more than tripled and in some cases quintupled since the war started. Kremlin statistics show that those workers who were paid between 18,000 and 25,000 roubles per month in December 2021, are now being paid 120,000 roubles. No wonder Putin’s popularity ratings are envied by most world leaders.
The principal reason for this upsurge in the cost of labour is Russia’s shortage of manpower—the classic supply and demand effect. When it became clear in March 2022 that the initial attack on Ukraine had failed, almost a million young Russians fled the country to avoid being conscripted and face almost certain death on the battlefield. This dramatic loss of manpower, coupled with a falling birth rate and the slowdown of Russians returning to the motherland from Central Asia, has led to a dwindling supply of much needed workers in the defence industries. The overall unemployment rate in Russia is currently down to an all-time low of 2.7%, compared with 4.1% in America—something which Putin loves to boast about whenever he has the opportunity.
The increase in government spending is predictably fuelling a boom in consumer spending, which in turn is bringing in higher tax revenues, allowing the government to spend even more. The inevitable consequence of this demand/price spiral is inflation, which annualised in 2022 at 13.7%, although it has now dropped to around 9%. To control this upsurge, Russia’s Central Bank raised interest rates on 25 October to an eye-watering 21%, well above the levels set in Western economies even during the inflationary crisis of the 1970s. Some essential food items have risen by more than 25% in the last year. On Russia’s social media, clips have circulated of shoplifters raiding supermarket counters for butter, which has rocketed in price.
Of particular concern to the Kremlin is the value of the rouble, which experienced a sharp drop last week plunging to levels not seen since the early days of the war against Ukraine when it briefly dropped to 120 to the dollar. Prior to the invasion, the rouble traded at around 80 per dollar, and before the illegal annexation of Crimea in 2014 it was under 40. Two weeks ago, the rouble dropped 15% against the US dollar when Washington sanctioned 50 Russian financial institutions including Gazprombank, the Russian bank which is a major supplier of foreign currency to the Russian market, and which also handles the country’s energy trade with Europe. The rouble strengthened slightly following the Central Bank’s announcement last week that it would defer purchases of foreign currency until 2025. But this is merely kicking the can down the road, as most experts forecast a further weakening of the rouble and a sharp rise in inflation early next year.
This all exposes deep structural problems in Russia’s economy. Any country that shifts to a wartime economy can expect to see a rise in GDP. After all, war is an economic activity, the largest imaginable Keynesian-style fiscal boost, and the Kremlin’s spending on its invasion of Ukraine has been huge. In effect, Putin is aggressively subsidising the lifestyles of Russian citizens with massive public spending. But because there are no capital flows and almost no capital investment in Russia, the demand for imported goods keeps growing and the rouble keeps getting weaker, all of which increases inflation. Russia is heavily dependent on imports and the Kremlin’s push to replace foreign products with “made in Russia” alternatives has largely failed, with the exception of the food sector.
The real financial strain is expected to hit in January, when consumer goods are expected to surge by at least 20%, due to the renewal of retailer contracts which until now have secured products at an exchange rate of approximately 85 roubles to the dollar. The cost of transportation will rise, especially that of importing goods from Asia, Russia’s main trading partner following the sanction from the West. It’s reported that “friendly” countries such as Turkey, Egypt and Iran have temporarily suspended fruit exports to Russia due to the rouble’s collapse.
The big question currently occupying minds in the Kremlin is what will happen when Donald Trump assumes office next month. Trump has boasted that he will stop the war in Ukraine in 24 hours, which can only be achieved if Kyiv hands over Crimea and large swathes of the eastern part of the country to Russia—an unlikely prospect. Even so, while the stopping of the war might help Russia’s manpower problem, Trump is promising a world of de-globalisation and trade barriers which will inevitably lead to a global financial slowdown and reduced consumer demand for oil, Russia’s main export since gas was stopped by pipeline closures and sanctions. He believes that bringing down the cost of energy is essential if he is to achieve the economic miracle he plans to be his defining legacy. Trump 2.0 wants energy that is cheap, reliable, domestic and secure. According to a report by Russia’s Central Bank, if the global oil price falls below $60 a barrel, caused by reduced demand and increased supply (Trump promised to “drill baby, drill”), Russia’s national wealth fund could be depleted in about a year.
What has become abundantly clear since Putin’s catastrophic decision to invade Ukraine is that his 25 years at the helm have been little different to the Soviet era—he has again made Russia a military giant but an economic dwarf. His gangster state has failed to diversify and produce goods that would attract customers from around the world, despite having world class levels of education and prowess, talents that have been largely wasted. Ask any man in the street to name an export from Russia and the answer will almost always be oil, the price of which will drop significantly as the world turns away from hydrocarbons. Under any other regime than Putin’s, Russia could easily have emerged as one of the top five or six economies in the world. Instead, despite experiencing a sugar-rush-GDP of 3.9% this year because of spending on the war, the world will witness the gradual decline of Russia’s economic significance as the future unfolds.
* John Dobson is a former British diplomat, who also worked in UK Prime Minister John Major’s office between 1995 and 1998. He is currently a visiting fellow at the University of Plymouth.