Commentary on Political Economy

Thursday 2 May 2024

Russia’s new economy may end up prolonging its war

The writer is a non-resident senior fellow at the Peterson Institute for International Economics and director of the International Affairs Program at Kyiv School of Economics Elina Ribakova · 3 May 2024

The Russian economy’s increasingly structural militarisation significantly complicates any efforts to end the war in Ukraine. Contrary to the expectations that economic constraints would hinder Russia’s capacity to sustain fighting, the spectre of economic collapse might push Vladimir Putin and his officials to double down on militarisation and seek further confrontation, even if aggression against Ukraine hits a standstill.

Russia’s economy grew by 3.6 per cent in 2023 and is projected to expand by over 3 per cent in 2024. Despite ongoing extensive sanctions and export controls, which are expected to hinder investment and potential growth in the long term, Russian authorities have praised themselves for their short-term success in avoiding a deep recession in 2022 and achieving subsequent strong growth.

Much of this success relies on the expansion of the military-industrial complex. The delayed and imperfect introduction of the oil price cap has enabled Russia to bolster fiscal revenues and use them to stimulate the domestic economy. While export controls impede Russia’s military production and make it more expensive, they have not yet resulted in decisive choke points or disruptions in supply chains.

Fiscal spending has focused on supporting war-related production. Direct military spending more than tripled to over $100bn (6 per cent of GDP) relative to the pre-2022 invasion of Ukraine. With over a quarter of Russia’s government expenditure hidden from the public, the actual war-related spending is likely to be substantially higher.

Russia now boasts 6,000 militaryindustrial enterprises, a notable increase from the prewar figure of less than 2,000. These establishments collectively employ over 3.5mn individuals who operate round-the-clock, with three shifts and six-day workweeks becoming the norm.

Since Russia’s full-scale invasion of Ukraine, the workforce in this sector has expanded significantly, with at least half a million new employees. Additionally, these salaries have surged by 20 per cent to 60 per cent since the onset of the war and many companies are offering exemptions from the military draft.

This heightened demand from the military sector, coupled with the loss of life resulting from the war, has propelled Russia’s unemployment rate to an all-time low of 2.8 per cent.

Industrial output is also on the rise, propelled by sectors such as metal products, machine building and chemical production. This can be at least partially attributed to the military-industrial complex. Employment, income and tax collection are also all reaping the benefits of the war boom. Regional governments report that this surge is accomplished “by the establishment of new production facilities, including the creation of industrial parks, the development of enterprises, and the creation of a significant number of new jobs.”

Moreover, regions that struggled for years to make ends meet are now experiencing a significant upturn due to the reorientation of production towards the war effort. For Russia’s citizens, the decision to support the war is no longer merely influenced by political rhetoric and propaganda; it is now also driven by pragmatism.

At the same time, the shift towards war-related activities is no longer merely a cyclical, short-term policy measure — it has become structural. While managing a cyclical adjustment might prove challenging, the Bank of Russia is making some efforts to temper the economy by maintaining interest rates at 16 per cent, significantly above the current inflation rate of 7.7 per cent.

However, reversing the structural investments made in the war will present a monumental challenge. For decades, Russia has struggled with under-investment and regional inequality, with only a handful of primarily commodity-producing regions being the net contributors to the budget transfer system. Past national projects and presidential decrees seemed incapable of changing that. However, for now, the war has.

Should the authorities attempt to halt militarisation, a hard landing could add pressure to the government, which already resorts to oppression to maintain power. Internal conflicts over limited resources may also intensify. Considering these challenges, it may be the more pragmatic choice for the government to continue militarising.

Rather than serving as a constraint, Russia’s economy might become an additional incentive to prolong its war in Ukraine.

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