Why Russia’s War Economy Cannot Sustain Itself
Marion Shuen, a first-year student studying English at the Department of English Language & Literature at UCL. She interned with the Singapore State Courts.
Russia’s protracted war against Ukraine has hindered its own economic performance. Despite its economic resilience and ability to cushion transatlantic sanctions by relying on backchannels for trade, escalating the conflict poses a threat to Russia’s ability to sustain its military expenditure. At present, Russia’s war economy is being suppressed by severe labour shortages and drained by its recent addition of RBS 3.4 trillion (USD 37 billion) to its budget this year. With economy minister Maxim Reshetnikov expressing that labour shortages are “the biggest internal risk for the Russian economy”, it is hard to envision the preservation of Russia’s economic stability and living standards without diplomatic efforts towards lasting peace.
As the Russian economy is bolstered by the energy sector and labour-intensive sectors, closer sectoral analysis is imperative, for they bear the greatest brunt of Russia’s invasion of Ukraine.
Foremost, the energy market, consisting of oil and natural gas, has experienced a drop in exports. Russian oil exports decreased by 70 thousand barrels per day (kb/d), reaching 7.5 million barrels per day (mb/d). Part of the reason why such a fall has occurred is because the overall decline in product flows worldwide has superseded Russia’s 50% increase in crude oil shipments. The futility of Russia’s efforts to circumvent the G7 Price Cap can be seen in lower government tax revenue, which threatens the fiscal sustainability of the war.
The steady decline of government tax revenue, coupled with the USD 25 million fall in export revenues, have forced the Kremlin to increase their budget deficit to Rbs 3 trillion ever since Russia’s full-scale invasion of Ukraine in February 2022. Although this Rbs 3 trillion budget deficit constitutes 1.8% of Russia’s GDP and thus only falls slightly short of the 2% deficit that the Kremlin originally planned for this year, it is even more important to note that wages are not expected to rise concurrently. Hence, the additional expenditure on military output puts Russia at macroeconomic risk. Ballooning expenditure and stagnant wages concomitantly worsen inflationary spirals that weigh on Russia’s living standards.
Labour-intensive markets, like manufacturing, are also constricting Russian macroeconomic growth. Defence companies are pulling more workers into arms production especially because of depleting Russian weapons. 300 thousand men were suddenly mobilised this year, starving civilian sectors of labour. Furthermore, many more have emigrated to avoid conscription. The competition for scarce factors of production is thus overridden by Russia’s recruitment of people on the frontline, tipping the balance of the war efforts and macroeconomic stability as the economy continues to operate at full capacity. With factories operating in 3 shifts and work weeks increasing, it is no surprise that UPF’s Enikolopov concludes that “The Russian labour market and the whole economy is working at its limit, it has been squeezed to its maximum capacity and it simply cannot produce more.” The exodus of already limited manpower has thus reduced the productive capacity of the Russian economy. The Russian economy is further hampered by the crowding-out effect. Oleg Deripaska, a metals and mining tycoon, stated that “state capitalism has money, capital and orders. They have money, they will recruit, they will compete.” Given that the top priority of Russia lies in national defence for now, funds are rapidly being diverted away from the private sector, stunting and contracting the growth of specialist industries like Information Technology and the legal service.
The economic shortcomings of Russia’s current war-driven economic strategies undermine Putin’s lofty goal to extend the war against Ukraine. Preserving economic stability and ensuring decent living standards cannot be achieved without the recovery from the budget deficit. This poses a formidable challenge because of the overheating of the labour market. As such, alternative methods need to be adopted to address the root cause of Russia’s macroeconomic crunch, though they each come with their drawbacks. Falling back on reserves might not insulate the economy as not all the sovereign-wealth fund’s assets are liquid. Raising taxes to increase government tax revenue would decrease household disposable incomes, further reducing citizens’ standard of living. It is thus evident that Russia’s war economy can only sustain itself insofar as current reserves go.
