In March, 2022, a few weeks after Russia invaded neighboring Ukraine, Western countries began sanctioning the Russian economy. The sanctions were designed to hurt the Russian war machine and provide “severe and lasting economic costs” to the Russian population. A year after the initial impact of the sanctions, the Russian economy has not been crippled, and in fact is expected by the IMF to grow by about 0.7%, or on a par with France. By contrast the British and German economies are expected to shrink, and the U.S. economy would also shrink if the long-anticipated recession occurs. It looks as though the sanctions have failed in their purpose. Or is that not the case?
Sanctions Have Only Limited Restraining Effect: From the beginning, the Western sanctions had holes in them, and Russian leaders have found ways to exploit them. This has helped the government to maintain an invading force while at the same time staving off a sharp decline in the standard of living at home. Sanctions aimed at the Russian oligarchs have frozen assets of about $100 billion. The oligarchs have faced travel restrictions and had yachts impounded, but apart from that they are still living very good lives elsewhere. Financial sanctions, especially removing Russian banks from the SWIFT system of money transferring, have failed to cut these lenders off completely as other systems such as CIPS, the Chinese alternative, have helped pick up the slack.
Surrogate Countries Help With Imports: Imports to Russia by way of intermediary countries has risen significantly. Countries such as Armenia, Serbia, and Kazakhstan have suddenly increased their imports from Western countries and correspondingly have increased their exports to Russia immeasurably in the last year in the face of sanctions. These middlemen have enabled Russia to beat the sanctions to some extent, but they are unable to cushion the sanctions’ impact completely. The shipping costs of merchandise shipped to Russia from countries other than Europe are much higher translating into higher prices for the consumer. Further, supply chain problems made famous during Covid-19 are still bothering different sectors of the Russian economy. Russian exports are also suffering, but their main export, crude oil, has been dealt with carefully by Western countries so as not to upend world markets. Nonetheless Russia is currently shipping about 3.7 million more barrels of crude per day than it did two years ago, albeit with a lower profit margin. A constrained price is helping countries like India and China to buy larger quantities of oil at what amounts to them as a huge discount.
Government Revenues Decreasing: Lower prices for their petroleum means lower sales revenue and lower tax revenues for the government. It also means its current account surplus (trade surplus) could evaporate. For 2022, Russia ran a deficit of approximately 2% of GDP. This year that same figure could go as high as 5% of GDP. But the government maintains a sovereign wealth fund that comes to about 10% of GDP. The government has the financial power to run deficits of up to 10 trillion rubles for the next 25 years if necessary. Financial factors are not likely to force the government to withdraw from the war, but it may result in a decrease in the effort that the government could make in the field. Analysts are noting that the quality of Russian war materiel is decreasing owing to losses of their best, top-flight, weapons and munitions. The weapons factories are busy working on the situation, but face shortages of crucial components such as advanced microchips, and jet or rocket engines. They have been known to cannibalize parts from civilian aircraft, and take chips out of washing machines for use in military hardware.
Human Resource Issues: Wars require manpower—especially if they are fought to attrition. Russia’s fortunes on the battlefield have not been good, and a great many casualties have occurred. With the major call down for more enlistees last autumn, the ranks of available workers in the private sector in the same age range as soldiers have declined considerably. Making matters worse, many other young men and women in that age range have left the country to avoid being conscripted into a war that they believe has no purpose. The results are that in the calendar year 2022, there was a 1.3 million person decline in the number of workers available for work under age 35. There are approximately 2.5 job vacancies for every unemployed worker in Russia. A long, protracted war that the population deems not to be critical for national defense, could cause a major backlash similar to what happened in the U.S. during the Vietnam War in the late 1960’s and early 1970’s. Add in a high casualty rate, and it could become a recipe for major unrest, especially in urban areas.
Declines in Living Standards: Vladimir Putin himself is concerned that the sanctions “may indeed have a negative impact on” the domestic economy. Efforts have been made in the form of government spending on social programs to try to keep the economy stimulated and avoid a decline in the standard of living for most Russians. Some handouts and an effort to keep banks from pressuring businesses for loan repayments is also in effect. The Pension Fund spends money not only on retirees, but also on the disabled, the poor, and the elderly.
Conclusions: In the 1940’s the Soviet Union made a maximum wartime effort in its economy that amounted to as much as 60% of GDP. However, they were in a desperate war with Nazi Germany that threatened to overrun their country and way of life. This war with Ukraine does not offer the same impetus, and it’s unlikely that Russia will be able to mount and maintain an all-out offensive that would be needed to achieve victory. Russia is further aided by trading partners that offer some support for their economy. In the event of a long war, it is not clear if this support will continue and if the steady erosion of the Russian economy will ever be abated. In the meantime, we can expect to see the war continue until attrition sets in, but at a much slower pace.
Sources: Military Industrial Complexity, The Economist, April 29th, 2023.