“Why is the Russian Economy Still Growing?”
“Growth despite Western sanctions”
The invasion of Ukraine led to Western sanctions against Russia which were promised to be the harshest sanctions to be implemented. The war is in its third year, and Russia appears to be stronger than ever and shows the willingness to continue the war for the foreseeable future. The supporters of sanctions should be asking why the efforts have failed to have the desired results and ruin the Russian economy but in fact, its economy is growing at a faster rate than the G7 countries that have pressed so hard for the sanctions? There are obvious sanction loopholes that are being exploited but is that the only reason why Russia appears to be growing militarily and economically while the West is not able to keep pace with war production and have GDP growth rates that are falling behind Russia? Has the West’s sanction regime and strategy to punish Russia for starting the war failed and have the opposite effect or is the Russian economic and military resilience an illusion?
The Russian – Ukraine war has shattered the Ukrainian economy which would be expected considering large portions of their country, especially in the Donbas and north of Crimea are occupied by Russia and no longer contribute to the Ukrainian economy. This is in addition to the bombing of targets inside Ukraine, throttling of Black Sea commerce, and the displacement of a large portion of the population who are no longer contributing to their nation’s economy. The first year of the war the Ukrainian economy to contracted by 30%. The second year of the economy saw a 5.7% annual growth compared to 2022 and the economy is expected to grow another 4.0% in 2024 but it won’t be until the 2030s that the economy recovers to the 2021 levels even with Western economic support that it is receiving in addition to military support.
The Russian economy by contrast grew a mere 0.6% in 2022 as Western sanctions impacted the Russian economy but in 2023 it grew by 3.5% and is expected to be able to operate with growth for at least the next two to three years. The 2023 increase in GDP was largely credited to Russia moving to a “wartime” production to support its war in Ukraine. The production of weapons and munitions, aircraft and rocket engines for missiles and combat vehicles all experienced increases in the Russian economy and their related industries which include technology categories such as computer, electronics, and optics. Sectors that have experienced decreases are mining, oil and gas. These reductions in oil and gas extractions appear to be less about demand reductions but Russia’s commitments to follow OPEC+ guidance to reduce oil production to keep the global price of oil elevated.
How is the Russian economy able to grow despite the Western sanctions against Russia? There are a number of theories that the conversion to a war economy has allowed Russia to make quick gains in defense related sectors but these year over year comps will not be expected to continue at this rate because the spending on the war has taken up the “slack” capacity in these industries that will be harder to comp in 2024, so growth is expected to slow in 2024 and after unless capacity is increased. There are also questions whether, due to the sanctions, if Russia will have the technology available to expand the capacity of their existing defense manufacturing base.
Western economic analysis cites that many young and educated Russians have left the country due to the war, especially in the IT and other technology sectors which will both have impact to future modernization and innovation in the economy. Basically, it is speculated that Russia is trading future growth to the support the current growth in the economy. The West argues that the Russian economy is de-modernizing and becoming more reliant on being a commodity-based economy. The “brain drain” is a legitimate argument, but if the Russian economy is de-modernizing, why is the computer, electronics, and optics sector of the economy growing?
Western sanctions have focused on the technology sector and has cutoff the supply of computer chips to Russia which are needed for modern weapons but the sectors that rely on these computer chip components is one of the fastest growing sectors of the Russian economy. The leaders of the G7, who met in Capri Italy in mid-April, are aware of this issue and are of the belief that China is helping Russia circumvent sanctions in these sectors. China has tried to play a neutral party in the conflict and agreeing not to supply weapons to either side, but China has also re-affirmed its alliance with Russia, so it is playing both side of the conflict. Ukraine not wanting to upset China, has distanced itself from China’s alignment with Russia and have not criticized it for its position.
After the G7 summit, U.S. Secretary of State Antony Blinken will travel to Beijing and Shanghai China to discuss several issues with Chinese leadership, including China’s support for Russia during the war. The State Department, in alignment with the G7, has accused China of supporting Russia which is threatening European security. It does not accuse China of providing weapons to Russia but that it is providing machine tools for factories, semi-conductors, and dual use items (items that can be used for both military and civilian applications) to help Russia move to a wartime economy and may even allow it to expand its defense industrial capacity for modern weapons even with the Western sanctions.
Blinken is expected to address this “backdoor support” for Russia, and it is helping Russia to get around Western sanctions and increase its defense production. The Germans have also taken a hardline stand against this type of support from China, and it can be expected that the German position will be reflected in European Union policy. Blinken can be expected to carry this message to China’s Foreign Ministry and possibly threaten to sanction Chinese companies and individuals that help Russia get around Western sanctions.
The other issue is that Russia has not been completely cutoff from its primary source of income and that is the sale of oil on the global market. Wars are expensive and Russia has managed to maintain finances through energy sales to support the war and has worked within OPEC+ to cut back on the organizations oil output goals to keep the prices higher. Higher prices due to lower output only helps Russia to fund its war. The West has sanctioned Russian oil using price caps on how much Russia can sell their oil on the international market and have placed limits of the insurance of tankers carrying Russian oil. Europe has also relied on a public relation campaign to shun companies not to buy Russian oil. Despite these measures, and oil being a fungible product, Russia has been able to sell its oil both in Europe and to China and India who receive Russian oil at a discount.
The U.S. at the time of the invasion was already suffering the effects of high inflation and did not want to see Russian oil production pulled out of the global supply and sharply increase prices and further exacerbate U.S. inflation and erode domestic support for the war. The European Union being highly dependent on Russian energy could not afford to be cutoff from Russian oil and gas, so it relied on oil and gas from other sources outside of Russia to keep its energy dependent economies going.
Those customers who used to receive non-Russian oil and gas would switch to Russian oil and gas to meet their energy needs (the byproduct of not sanctioning completely a fungible commodity). Oil contracts and distribution was impacted and caused a spike in oil, but the market eventually adjusted because Russian production was still available to the globe. Another factor that demonstrates the West’s desire for Russian oil to stay on the market and not have global supply disrupted is that it has requested that Ukraine not attack any Russian targets connected to the oil and gas industries. This demonstrates that the West’s energy sanctions were half hearted and guaranteed that Russia would be able to fund the war in Ukraine.
The West’s sanctions against Russia were bound to fail because through its own decisions not to be energy independent has left them vulnerable to the energy producing nations. Slow growth GDP and stubborn inflation in G7 countries meant they had limited ability to weather the impact of cutting off Russia’s main source of income. So, Russia can still produce and sell its main source of income to fund its war, so it allows Russia to pay for items from Chinese companies to expand its war industries. It is true that Russia is trading its future growth by giving up progress in sectors that would help it diversify from a commodity-based economy. The Russian government is also becoming more involved in the economy to make it more of a command-based economy which will eventually decrease efficiency and innovation in the Russian economy. However, for the next three years, the West’s half-hearted measure ensure that Russia will stay in the war. Another reason to find a way to end this war.
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References:
https://carnegieendowment.org/politika/89052
https://www.europarl.europa.eu/RegData/etudes/BRIE/2024/747858/IPOL_BRI(2024)747858_EN.pdf
https://www.usip.org/publications/2024/03/ukraine-war-takes-toll-russia