Malignant growth: Rumors of a Russian economic recovery have been greatly exaggerated

RU

Experts have long agreed it is a grave mistake to believe that war actually benefits the economy of a belligerent nation. Resources are always limited, and if the war effort is consuming raw materials, capital investment, and human labor (to say nothing of human lives), there will be fewer resources left over for everything else. Nations at war sacrifice their material well-being, a fact understood by Frédéric Bastiat as early as 1850, when he published “That Which Is Seen and That Which Is Not Seen.” This is true in Russia’s case as well. Consumer consumption and business investment are down, even if some economic indicators appear to have improved when compared with their peacetime benchmarks.

Statistics suggest that the Kremlin’s full-scale invasion of Ukraine delivered less of a shock to the Russian economy than the COVID-19 pandemic of 2020-2021 or the oil price collapse of 2015 did — and certainly less than the financial crisis of 2008-2009. After all, in 2023 Russia's real GDP was seen to grow by 3.6%, and the first quarter of 2024 was marked by a further expansion of 5.4%, the Russian Ministry of Economic Development estimates. This pace noticeably exceeded forecasts, something the Bank of Russia proudly pointed out.

The manufacturing industry is responsible for a large share of that growth, with Russia producing machine tools and equipment to substitute for imports that fell prey to international sanctions. This wartime new reality has allowed the country to revamp its automotive industry (although production is still only 78% of pre-war output), and to set up domestic computer assembly capabilities. In addition, Russia’s machine-building output grew by 23% year on year to March 2024, withy construction, wholesale and retail trade, and public catering also on the rise. However, “a conclusion about the transition to a full-fledged recovery would be premature,” economists at Russia’s Center for Macroeconomic Analysis and Short-Term Forecasting note. According to their calculations, the March numbers were not the result of any actual improvement in the economy’s capacity to provide Russians with a better material life, but rather came courtesy of “increased hydrocarbon production (by indirect estimates) and a surge in the production of electronic machinery, electrical equipment, and aircraft.”

How much is the war costing Russia?

Judging by the numbers, Russia’s federal budget is doing well. In March 2024, it was reported to be in surplus, and the overall deficit from the first quarter of the year was negligible: just 0.3% of GDP. “On the whole, the situation is going as planned, without emergencies,” Finance Minister Anton Siluanov said in an interview published on April 11. Siluanov expects the end-of-year deficit to remain within $15.3-16.3 billion range, a figure below the prescribed $17.4 billion (0.9% of GDP). The aggregate projected deficit for the federal budget and all regional (“consolidated”) budgets and extra-budgetary funds is expected not to exceed $21.8 billion, or 1.1% of GDP.

In this regard, the Russian state stands out for its restraint. Among G7 members, only Germany and Canada boast a deficit-to-GDP ratio smaller than that of warring Russia, and developing countries’ balance sheets are often even deeper in the red, as China ( 7.1% deficit relative to GDP), India (8.8%), Brazil (7.1%), and Turkey (5.4%) show. Securing a better financial balance than states living in a state of peace stands as a legitimate achievement for the Putin-Siluanov duo.

Things could certainly be worse. Despite receiving an outpouring of international moral support and material aid, Ukraine’s economic situation is far more troubling. Kyiv’s budget deficit in 2023 was estimated at 19% of GDP, and the International Monetary Fund expects that figure to remain nearly as large in 2024. While Ukrainian drone strikes continue to take a toll on Russia’s oil refining capacity, Ukraine itself has lost nearly its entire steel industry due to the war, along with large swathes of agriculturally rich territory, millions of working-age citizens, and dozens of towns and cities rendered unlivable by Russian shelling.

So far, the direct costs to Russia resulting from the war have been surprisingly cheap. Overall budgetary spending since the start of the full-scale invasion has grown by between $21.8-27.3 billion a year — only 1.3% of GDP. However, indirect losses are much higher. A rough estimate can be provided by looking at the dip in budget revenues, which have fallen from 35.6% of GDP in 2021 to 32.4% in 2023. That gives us a shortage of 3.2% of GDP, or $60 billion a year. The system wants to make up for this lost revenue by raising income tax rates and returning to the pre-2001 progressive scale. Even if its budget deficit is small relative to that of comparable countries, the Kremlin appears intent on keeping it in check.

On the one hand, such fiscal responsibility is an important element of Putin's policy, ensuring his system’s sustainability. On the other hand, experts warn that such tight-fistedness could double as the regime's Achilles’ heel. Raising tax rates is a risky strategy that can narrow the tax base in unpredictable ways. As a result, tax revenues may eventually decrease, dragging down economic activity along the way. The higher new rates would also drive up the share of the shadow economy as more businesses and individuals grow dissatisfied with the share of their revenues they owe to the state.

Judging by his public statements, Putin harbors false hopes about the capacity of the Russian economy to produce healthy growth. Instead, since the start of the “special military operation,” any on-paper increases in Russia’s GDP have largely failed to produce any sign that overall economic welfare is rising in tandem.

Growth without improvement

In theory, the growth of total income in an economy is followed by an increase in sales, and car purchases serve as a fairly reliable proxy for economic health (as was demonstrated by Michael Sivik of the University of Michigan). Russia’s automotive sector has unquestionably suffered since Feb. 24, 2022, and its recovery has been less than spectacular. Although in 2022 the country’s officially reported constant price GDP fell by only 1.2%, car sales plunged by 59%. Despite official GDP growth of 3.6% in 2023, they rose by only 38% year-on-year, bringing the number of sales back to just 57% of what it had been the year before the start of the full-scale invasion. Notably, even in 2021, Russians were already buying fewer cars than they had prior to the pandemic (1.66 million vehicles against 1.76 million), and in turn, the pre-pandemic level was already significantly lower than that of 2013 (2.77 million), one year before the annexation of Crimea.

Of course, car purchases have also been affected by the decline in supply. Some Russian brands fell under sanctions and became more expensive after imported parts started to arrive in the country following a more circuitous route. In addition, Western manufacturers that formerly assembled vehicles in Russia have withdrawn from the market, limiting both competition and consumer choice. As a result, in 2022 Russian factories turned out one-third as many cars as they had in 2021, and the 2023 recovery improved on that figure by only 19%, leaving production below 2009 levels. In short, since Feb. 24, 2022, both supply and demand fell dramatically, and any gains made since reaching the depths of the crisis have failed to come anywhere close to returning the country to its relatively modest standards of pre-war prosperity.

Another clear sign of a population's wealth is its ability to travel the world. Here too, a consumer-oriented indicator of economic well-being delivers less than happy results. Admittedly, restrictions on foreign travel during the height of the coronavirus pandemic make this data more difficult to interpret, but by going back to 2019, we can see just how isolated Russians have become. In 2021, year two of the global health crisis, they made 21.3 million trips abroad, In 2022, year one of the full-scale war, they made 24.3 million. And in 2023, the year of the Russian economy’s supposedly miraculous recovery, the number was 27 million. However, even this latter figure lags well behind the 48 million trips abroad that Russians made in 2019, which in turn was already less than the 54 million they took in 2013, the year before Russia’s illegal annexation of Crimea.

Notably, this negative trend in foreign travel is not a result of the fact that, at least according to Russian law, as of Mar. 18, 2014, travel to Ukraine’s Russian-occupied Black Sea peninsula was no longer considered “foreign.” In 2013, Russians took 1.45 million trips to Thailand, a figure that had shrunk to 1.23 million by 2019 and fell further to 1.06 million in 2023.

More guns, less butter

Changing economic priorities — along with sanctions — have affected the shopping baskets of Russian consumers. While it is true that nominal wages are rising (mostly due to the trickle down effects of skyrocketing military budgets), they do not stretch as far as they once did for certain staples including beef, butter, and sugar. If we take the year 2013 as a reference point, 14 out of 24 tracked items have become less affordable. Rice has seen the largest relative price increase: before 2014, the average Russian consumer could buy 615 kilos of rice with their monthly income; ten years later, that figure is 440 kilos.

And even if we were to take the official economic growth figures at face value, they do not match those of most developed countries. Russia’s real per capita GDP in 2023 was 10% higher than it was a decade ago, meaning it had been growing at about 1% a year. To compare, the U.S. experienced a per capita GDP growth rate of 1.5% per year during that time, Portugal's was 2.2%, and Poland's was 3.2%.

Construction mania amid depression

Among Russia’s civilian industries, only construction is growing, as demonstrated by an increase in the number of new high-rise residential development projects. Real estate revenues have been growing for three years in a row: by 44% in 2021, 7% in 2022, and 39% in 2023, and the mortgage portfolio of Russian banks has followed a similar trend. Mortgage loans now account for 54% of all credit outstanding and 65% of the annual rise in borrowing.

Still, even this growth appears to be less than organic. The jump in mortgage lending has come largely thanks to government subsidies, with artificially cheap mortgages accounting for almost 95% of lending in the multi-unit sector. The year 2023 saw a record number of apartments sold in new buildings, with 773,000 shared construction participation agreements being signed between developers and future property owners, a figure 42% higher than in 2022 and 14% more than in 2021.

The Russian government runs two housing subsidy programs: “preferential” mortgages (with an interest rate of less than 8% a year) and “family” mortgages (with an interest rate of 6% or lower). Private banks issue corresponding loans at much higher rates (currently 16–17%), meaning that the price difference for qualifying borrowers is covered by funds from the federal budget. This pandemic-era relief measure turned into a permanent one, with snowballing subsidies creating a dependency for the new-build market. In his address to the Federal Assembly on Feb. 29 of this year, Vladimir Putin proposed extending Russia’s housing subsidies program through 2030.

Moreover, the government cannot simply stop subsidizing loans that have already been issued. For many families, mortgage payments are a major expense item in the budget, and the Russian authorities will have to support these families for another 20-30 years until their debts are fully repaid. The only way to curb the growth of budget expenditures is to stop issuing new soft loans, and yet every time subsidy programs are extended, these loans only become more numerous.

As a result, Russia went from spending $21.8 million on mortgage subsidies in 2019 to $437.2 million in 2020. However, even that figure pales in comparison to the $4.9 billion that the 2024 budget has allocated for housing subsidies: $2.5 billion for preferential loans and $2.4 billion for family loans. Future budget plans suggest a slight decrease in these expenditures, as Siluanov estimated $16.4 billion would be spent in total by 2030, which translates to around $3.3 billion a year. Whether the plan to tighten such expenditures will actually be fulfilled, of course, remains to be seen.

Government-subsidized construction as a primary driver of economic growth is bad policy under any circumstances — whether or not a nation happens to be fighting a wholly unjustified war of aggression. No subsidies exist in a vacuum; they are always issued at someone's expense, and the more subsidies any one industry receives, the fewer opportunities there are for sustaining and developing other areas of the economy. Moreover, government support for individual industries or markets weakens the natural feedback loop of the economy, it distorts incentives, and it creates unrealistic expectations. As history shows, such distortions are usually removed by a sudden, unmanageable crisis. Simply put, the “success” of Russia’s wartime economy has been greatly exaggerated.