Vladimir Jushkin ⟩ The future of the Russian economy is growth without development

Photo: Oleg Elkov / Shutterstock

Vladimir Jushkin, director of the Baltic Center for Russian Studies, writes about the paradoxes of Russia's war economy and why it has proven to be resistant to sanctions.

At the end of last year, well-known Russian economists (Sergey Aleksashenko, Vladislav Inozemtsev and Dmitry Nekrasov) published a report called «The Dictator's Reliable Rear», which examines the limits of Russia's resilience.

The report’s general conclusion is that the Russian economy has been able to withstand the blow caused by the Western sanctions due to the nature of the Russian market, its indispensable position as a supplier of primary commodities to the global market, highly professional responses by its government officials, and the West’s inability to isolate Russia on the international stage.

The current stance can be described as a «growth without development» being characterized by a quantitative increase in the volume of production of long-mastered products, an expansion of the service sector, and limited modernization of infrastructure without significant technological progress.

The current economic structure is capable of meeting the needs of the Kremlin’s military machine in the years to come while providing the financial resources needed for funding welfare programs on a scale preventing an increase in protest sentiments. An assessment of the potential of the Russian economy excludes almost any chances of a serious crisis caused by internal factors in an at least three-to-five-years’ perspective.

For the international community, the most dangerous effect of current trends may be the rise of a Russia-centered group of economies championing massive violation of intellectual property rights, illicit foreign trades and the use of non-traditional forms of international settlements. The Kremlin sees opportunities for institutionalizing this model and is laying it down as the basis for its geopolitical claims, trying to establish itself as a leader of a «non-Western» community of nations.

Contradictions of expert assessments

According to the report's authors, three groups of experts are currently working on Russia. The first group consists of longtime Russia specialists who view current events through a Soviet-era lens, interpreting Putin’s dictatorship as an attempt to restore the Soviet system. The second group includes analysts who work in one capacity or another for officials of Western governments, and feel compelled to propose sanctions and restrictions, projecting confidence in their effectiveness. The third group is made up of experts with Russian backgrounds, including those former politicians who despise Putin and are convinced of his regime’s imminent collapse.

The current economic structure is capable of meeting the needs of the Kremlin’s military machine in the years to come while providing the financial resources needed for funding welfare programs on a scale preventing an increase in protest sentiments.

The assessment of the possibilities of sanctions policy has hypertrophied. Of course, if an energy embargo could eliminate oil and gas revenues from the Russian budget, deprive the Russian military-industrial complex of the opportunity to receive modern technological components, trigger numerous defaults, or provoke hyperinflation, it might be worth the price. The West’s inability to attract China and India to its side has produced huge holes in the sanctions’ «fence», which has sharply reduced the effectiveness of the decisions taken.

Paradoxes of the war economy

First, increased military spending stimulated consumer demand and industry. In 2023, the largest increase in gross value added was recorded in the activities of hotels and catering enterprises (by 10 percent), in the information and communications sector (by the same 10 percent), in financial and insurance activities (by 8.6 percent), in wholesale and retail trade (by 7.3 percent) and construction (by 7.0 percent), which reflects an increase on the share of final consumption expenditures in GDP to 68.7 percent from 64.9 percent in 2022, including the share of household expenditure to 49.8 percent from 47.4 percent.

In other words, final domestic demand continues to be a more significant growth factor than exports. For example, in the construction sector alone in 2023, up to 30 million tons of steel were consumed (the increase from the previous year amounted to 9 percent), while in 2021, just over 15 million tons were exported.

Secondly, during the war, real disposable incomes started to increase after the longest period of their fall in Russian history – from 2014 to 2021, the total decline in real incomes, according to official data, exceeded 3.3 percent. In three years since the start of the aggression against Ukraine, this figure will grow by at least 17.5 percent (4.0 percent in 2022, 6.9 percent in 2023 and, according to the government forecast, about 7 percent in 202419). A significant contribution to this dynamic was, of course, made by disbursements to the military personnel – since the fall of 2022, contract soldiers at the frontline were paid at least 195,000 rubles per month, and in 2024 the amount was increased to 210,000 rubles (or 2.5-3 times the average salary in Russia) while federal and regional one-time payments for signing a contract today vary from 800,000 to 3.4 million rubles. According to calculations by independent experts, from mid-2023 to mid-2024, the federal budget had paid out to the military personnel and their relatives at least three trillion rubles in salaries and compensation that equals 1.8 percent of GDP, and government economic analysts openly call the recipients of these funds «the new young rich».

This hike in household incomes turned out to be the most unexpected phenomenon of the first war years: traditionally, in Russia, wars had led to the opposite – to a sharp fall in consumption due to a growing budget deficit; to a freeze of income through forced loans; to unpaid employment, etc. But today’s Russia turned out to be not another Soviet Union, but rather resembled Israel, where the economy grew by an average of 4.3 percent annually from 1970 to 1990 without facing a single recession, despite defense spending averaging 18.6 percent of GDP during this period.

Foto: A man in an ushanka hat passing the main building of the Russian central bank in Moscow on Dec. 15, 2023. Photo: MAXIM SHIPENKOV/EPA Photo: MAXIM SHIPENKOV / EPA

Authors of the report note that Russia’s economic growth is not organic – it is without a doubt fueled by both direct government investment in the military-industrial complex and infrastructure projects, and various investment programs supported by federal benefits (the construction and reconstruction of highways, investments in housing and communal services, investments in the modernization of infrastructure in the capitals and large regional centers).

Thirdly, the Bank of Russia’s policy of combating inflation by raising interest rates has not yet caused fatal problems for businesses, but has provided the upper strata of the population with a new source of income, allowing them to deposit their money at an interest rate that fully compensates for the inflationary effect. From January 2022 to September 2024, household deposits in Russian banks grew by a record 53.8 percent over such a short period, which reduces the feeling of anxiety associated with the ongoing war.

Why is Russia’s economy resilient?

The first and most important resilience factor is the free market character of the Russian economy. As Vladimir Putin established control over Russia’s largest corporations, the idea of the «étatization» of the Russian economy and, consequently, about its growing similarity to the old Soviet one, penetrated the Western expert community. It was argued that the state controls 100 percent of the railway and pipeline infrastructure, and that by 2018 the share of state-owned companies in overall corporate revenue reached 63 percent in the oil and gas industry, 79 percent in the machine-building sector, and 92 percent in the banking business. It was assumed that the competence of state managers was low, that corruption was rife, and that all these enterprises were ineffective. Though indirectly, the observers then arrived at the conclusion that Russia’s economy could collapse just as easily as the Soviet one once did.

The readiness to adapt to changing conditions for the sake of survival could be seen in the Russian economy even after the wave of sanctions that had arrived in 2014-2015, and this desire became the main reason for its current stability. The lifting of several regulations in the first months of the war (primarily the legalization of «parallel imports», the nullification of Western companies’ intellectual property rights, and the expropriation of foreign direct investment originating from «unfriendly» countries) created new opportunities for hundreds and thousands of entrepreneurs, who did their best to adapt to the changing situation. In other words, it was the Russian economy's orientation towards private enterprise and the market that made it much more resilient.

It was the Russian economy's orientation towards private enterprise and the market that made it much more resilient.

Officials and businessmen cooperated in inventing smart schemes for circumventing sanctions (like the «shadow fleet») as well as in managing trade settlements in «non-traditional» currencies and concentrating in accounts in «friendly» jurisdictions the equivalent of at least 180 billion US dollars, about which reliable information is simply lacking.

Large Russian businesses hit by sanctions have used creative schemes enabling them to repatriate much of their assets back to Russia from the Western countries, and, through registering dozens of holding companies in Russian jurisdictions specially created for this purpose, made themselves «unattainable» to sanctions.

Putinomics after the war

According to the authors of the report, when it comes to medium-term forecasts, it is more appropriate to focus not on quantitative metrics but on the trends that characterize the key trends developing under the influence of militarization and shifts in relations with the rest of the world until the end of 2020s (as it is not possible to provide forecasts over a longer term).

First, it can be assumed that maintaining budget stability will remain one of the most important principles of Putin's economic policy. He has followed this principle throughout his reign.

Secondly, even if the active phase of hostilities ends and the Russian army undergoes partial demobilization, sharp cuts in military spending should not be expected. The Ministry of Defense will need to replenish its stock of military equipment, weapons, and ammunition, which will sustain production levels at defense industry enterprises. Leading analytical centers have noted a halt in industrial growth since May-June 2024, but they are not prepared to say whether this is a temporary «pause» before a new surge or a «leveling off». There is a labor problem. Defense industry enterprises, facing a large-scale order for weapons production, had to switch to a three-shift work schedule, requiring them to recruit around 600,000 skilled employees, and the only effective tool for attracting these workers was offering higher wages. Today, there is a remaining labor shortage of 160,000 laborers in the defense industry companies.

Foto: The Kremlin has been actively using the shadow fleet to evade sanctions. The West is trying to stop it. Illustration: Shutterstock / Madis Veltman Illustration: Shutterstock/Madis Veltman

Thirdly, after the defense industry, the domestic services market will remain the second most critical driver of economic growth and household income. This sector has already become the primary beneficiary of Western sanctions, government support for import substitution, and relatively liberal policies toward private entrepreneurs and the self-employed (whose taxes will not increase in 2025). Additionally, households have also become beneficiaries of the central bank’s interest rate hikes – despite a gradual reduction in the key rate throughout 2025, households could still receive interest income equivalent to about 3 percent of GDP. Of course, the distribution of income gains across the population will be uneven: around 60 percent of households lack financial savings and, therefore, aren’t able to benefit from elevated deposit rates. Nevertheless, in general, the combination of military payments channeled into economically depressed regions and more targeted social assistance from the budget means that the coming period, in terms of income growth, could be comparable to the best times for the Russian economy – the mid-2000s. Both economically and politically, this will be a significant factor in bolstering Kremlin support and a key resource for maintaining the much-touted «stability».

Russia today has a multi-year «safety margin» allowing its elites to pursue a policy of, if not permanent war, then at least aggravating militarization.

Fourth, the export of sanctioned goods (or those restricted by Western authorities) has now been almost entirely redirected from Europe to China, India, and other «Global South» countries, facilitated by a «shadow fleet,» informal currency and quasi-currency transactions. Within Russia, intellectual property rights are largely disregarded – from the «suspension» of patents and franchises to the unauthorized reproduction of audio and video content, as well as pirated use of software, including its export abroad.

Fifth, the problem of labor resources does not seem insurmountable, according to the authors of the report. For many years, Russia has tended to create «excess employment». In the current environment, should these corporations optimize their staffing, an estimated 1.5-2 million workers could be freed up. The Russian authorities are initiating at least two important changes in this area, which are likely to impact the country’s labor resources balance (a shift away from the easy accessibility of higher education and nearly compulsory redirection of individuals into technical colleges to secure employment at industrial enterprises. The Kremlin has considered reorganizing migration policy if it does not include naturalizing immigrants, but only using them as temporary labor.

Overall, the medium-term future of the Russian economy can best be described as growth without development.

All of the above does not mean that Russia is not currently facing, or will not face, severe crises in the future. The de-modernization of the economy, the catastrophic depletion of human capital, dependence on Asian economies that are secondary in terms of global technological progress, the breakdown of institutional frameworks, and the erosion of legal foundations for engagement with the rest of the world – these will all eventually be recognized as key elements of the economic degradation set in motion by Putin.

Thus, the world must be prepared if not for a new Cold War, then for a long confrontation with one of its largest economies, which has actually openly declared that it does not want to respect the basic principles of international law and at the same time cannot be effectively stopped by military or economic measures. Russia today has a multi-year «safety margin» allowing its elites to pursue a policy of, if not permanent war, then at least aggravating militarization, threatening the world with military and hybrid conflicts.