War and “economic war” over Ukraine

by the Editorial Team of Socialism.de

Russia's economy remains relatively stable

[This article posted on 8/3/2024 is translated from the German on the Internet, https://www.sozialismus.de/index.php?id=8087&tx_ttnews[tt_news]=20597&tx_ttnews[backPid]=6580.]

Ukraine is experiencing the hardest year in the war of position and attrition since Russia attacked the country on February 24, 2022. The Russian army has more tanks, more artillery, more aircraft bombs. According to military experts, the F-16 fighter jets recently delivered by the West will not significantly shift the balance of power.

The Russian advances of recent weeks have created a critical situation in parts of Donbass. Even more ominous is the weakening of the fighting spirit of the Ukrainians and the war fatigue among the Western allies. Even Ukrainian President Volodymyr Zelensky recently had to admit that not all occupied territories could be retaken “with weapons in hand”. However, the idea of a complete reconquest was never realistic, as resources were too limited.

Although Ukraine currently has the will to continue fighting for its survival, it lacks the resources, and the signs of exhaustion are unmistakable. After all, there is equally burgeoning resistance in many Western supporting countries to the high costs of military aid and aid payments for Ukrainian refugees.

And the results of the “economic war” are also rather sobering. Thousands of sanctions were imposed on Russia for its illegal attack. They affected the financial and trade sectors, as well as energy, transport, technology, and defense. In the energy sector, they serve two purposes: on the one hand, to harm Russia financially, and on the other hand, to prevent damage to the global economy and the sanctions coalition – by ensuring that Russian oil remains on the market.

This is what distinguishes the sanctions regime against Russia from others, according to Benjamin Hilgenstock, an expert at the German Council on Foreign Relations: “Very complex interventions are being made in global markets in order to achieve these various objectives at the same time.”

The fact is that the political goals have not yet been achieved. Russia is still waging war against Ukraine, and Vladimir Putin's authoritarian regime has hardly been weakened internally. Contrary to the repeatedly proclaimed political declarations of Western politicians, it can be stated for mid-2024 that the Russian economy is still in surprisingly good condition.

The latest EU sanctions package has just been launched, but Russia's economy is surprisingly robust. The IMF has even just doubled its growth forecast for the country to 2.6%. Hopes for a long-term weakening of Russia's economic substance are not well founded.

There are no signs of economic collapse and, in its wake, widespread social protest against the war. This is probably due to three factors. The first is described by political scientist Alexander Libman from the Free University of Berlin as follows: “Larger state military expenditures lead to an increase in domestic demand and also to rising wages.” This in turn strengthens private demand and the Russian domestic economy is running smoothly.

Libman has also identified a second factor: because many Western companies have left Russia, market niches have opened up that are now being occupied by Russian companies. Thirdly, the effectiveness of the sanctions is reduced because large economies continue to do business with Russia. The country continues to sell oil to China and India, among others. However, it has had to accept lower selling prices. In the case of gas, it is difficult to redirect supplies to Asia because there are not enough pipelines. Although this has led to shortfalls in revenue, they have not been dramatic. Russia can indeed sustain the costs of the war for several more years as long as China and India continue to buy raw materials there.

This overall assessment is confirmed by a new study by research institutes in Kiel, Munich and Vienna. The study concludes that the sanctions cannot stop the war. According to Vasily Astrov, Russia expert at the Vienna Institute for International Economic Studies (wiiw), Western politicians have overestimated their influence on third countries.

Regarding the effectiveness of sanctions against third countries, the wiiw notes: “The prospect of US sanctions against banks in third countries such as China, Turkey or the United Arab Emirates, which have so far helped Russia to circumvent Western sanctions, is increasingly having an effect. For example, Russian imports of goods from China fell sharply in March and April of this year. [...]

“The slump was particularly dramatic for dual-use goods, i.e. products that can be used for both civilian and military purposes – for example microchips,” states Astrov, but adds: ”Ultimately, ways will be found to circumvent these sanctions again, but they will make it more expensive and difficult for Russia to procure the high-tech components from the West that are so important.”

Shortly after the invasion of Ukraine, Russia experienced a recession of one percent. Since the fall of 2022, the Russian economy has been on the rise again, growing by 3.6% last year. On July 2, the wiiw published its “summer forecast” for the development of the economies in Central, Eastern and Southeastern Europe. It raised its forecast for this year's growth of the Russian economy to 3.2%.

A day later, the Russian statistics office Rosstat published further important economic data for May, including developments in consumption and income. Real growth in retail sales slowed further year-on-year in May, but still reached 7.5%. In the first five months, real retail sales were 9.3% higher than in the same period of the previous year. Real wages in April were 8.5% higher than a year earlier. In the first four months, real wages exceeded their year-earlier level by 10.5%. The unemployment rate remained unchanged in May at the historic low of 2.6% reached in April.

The enormous government spending on the war – around a third of the federal budget or 6% of GDP – is fueling the economy and benefiting many other sectors. The severe labor shortage caused by the deployment of hundreds of thousands of men at the front and emigration abroad is driving up wages and private consumption. The construction industry has benefited massively from the expansion of the military and transport and logistics infrastructure in the direction of Asia.

Added to this are the very high wages paid to front-line soldiers and the compensation paid to the disabled and the surviving dependents of fallen soldiers, which pumps additional money into the economy. “This leads to a redistribution from top to bottom, which unfortunately also increases popular support for the war,” says Vasily Astrov. However, it is also estimated that these factors make growth unsustainable and that the Russian economy is overheated.

Inflation is running at 8%, and the central bank is trying to combat it with a high key interest rate. The trade surplus has shrunk dramatically, which makes a significant difference in terms of macroeconomic stability and also in terms of political leeway. Another constraint is the freezing of assets by Western countries, including the fact that the Russian central bank cannot access reserves of 300 billion dollars. Part of the interest is used by the EU to purchase military equipment for Ukraine.

Russia's reserves to compensate for the budget deficits are also gradually dwindling. The country has already had to draw a quarter of its welfare fund to make up for this. The state-owned company Gazprom made more than six billion euros in losses in 2023. The Russian government spends 38% on the military, intelligence and police. The president and the government have already increased taxes on high incomes and corporate tax. The Russian economy is geared up for war in terms of production, the deployment of labor and shifts in the range of goods on offer.

The huge amount of the Russian state budget spent on defense is a huge burden for the economic future. Sectors such as the IT sector, artificial intelligence, but also health and science suffer from this, although they are of central importance for future viability.

Among the critical effects on the Russian economy is the tendency to decouple from Western productivity development. Russia still has access to technology goods thanks to China, India, some Arab states, Turkey, Kazakhstan, Kyrgyzstan, Uzbekistan and Armenia. And if the country is not allowed to buy microchips, washing machines from Western production are ordered to get the necessary components for controlling drones.

According to the Ukrainian presidential office, around 250 Western companies are indirectly supplying Russia with components for weapons. This is usually done covertly, as the manufacturers cannot trace where the customers resell the products. The new EU sanctions package was designed to prevent this; 26 member states wanted to extend the “no-Russia” clause to subsidiaries that are not located in the EU.

The German government has rejected this because of the alleged high costs. Most experts see little potential for tightening the sanctions. Firstly, because China and India are unlikely to support them, and secondly, because it is unclear whether the sanctions might not also affect the West itself. Greater realism regarding sanctions could be politically helpful.