Russia’s Economy: Closer to the Edge Than it Looks (2024)

The Russian economy is doing well. Vladimir Putin has repeatedly boasted about all-time low unemployment, real wage growth, and stable inflation. Confronted by an economically near-stagnant Western Europe and the failure of harsh predictions for Russia at the start of its all-out war on Ukraine, this unexpected affluence has provided a bonus for Putin in the hearts and wallets of the Russians. For now, at least.

The main driver of economic growth is gargantuan war-related state expenditure. For the first time in modern history, the country is set to spend 6% of gross domestic product (GDP) on the military this year, and defense outlays will exceed social spending.

In addition, there are also substantial state disbursem*nts on other war-related items — like construction in the occupied territories of Ukraine, mortgage subsidies to war veterans and defense sector workers, and domestic production of hitherto imported goods. Overall, expenditure is planned to reach 36.6 trillion rubles ($401bn) in 2024 (a 26.2% annual rise.)

This spending frenzy is funded partly by oil revenue, which Western sanctions failed to stanch. It’s also supported by increased tax collection, driven by higher economic activity. While both are rising, spending can be sustained, which aids the economy. Supported by fiscal outlays, meanwhile, the war industry is at full throttle. But therein lies the rub.

Military factories, barely working just five years ago, are running around the clock and constantly need workers. In this, they must compete with other industries and the army, which is constantly offering higher-paying contracts. No wonder salaries are increasing not only in the military sector but across the board.

A more granular analysis shows that the wages are rising above average in those regions with a heavier bias toward military production and construction, and with a higher share of contract soldiers. Growth is highest in the lower-to-middle-income parts of society, reflecting a constant competition for workers and soldiers.

However, rising demand for labor intersects with declining supply. Labor availability has been sapped by the military draft, emigration, and restrictions on Central Asian workers after the Crocus Concert Hall terrorist attack in Moscow in March. As a result, unemployment is setting new historic lows every month.

It is a basic tenet of economics that unemployment and inflation have an inverse relationship; higher inflation is associated with lower unemployment and vice versa. The so-called Phillips curve shows that at a certain point, even a tiny drop in unemployment results in a sharp rise in inflation.

Historically, the optimal level of unemployment for Russia, the level at which the economy runs at full capacity without overheating and causing a spike in inflation, is around 4%. In March, it was 2.7%, compared to the average of 5.1% in the decade up to 2022.

If productivity was rising, optimal unemployment would have declined, as it did in the 2000s, when Putin was still in the business of pursuing liberal economic reforms and sponsoring infrastructure projects. However, the Kremlin now pours money not into new roads or cutting-edge machinery, but into tanks and missiles.

The result has been that productivity suffered a profound decline in 2022 (just a notch better than in 2009, the year of the global financial crisis.) The Kremlin needs to fix this to make growth more sustainable

It also explains why inflation is running at twice the central bank’s target and refuses to abate despite a prohibitive 16% base rate.

Inflation and high interest rates act as additional taxes on low-income Russians, who need to spend a greater share of their incomes on basic goods and services and cannot borrow to cover declining real incomes. The state is thus forced to raise salaries and payouts for the disadvantaged to maintain social support, further fueling inflation. The state also subsidizes loans and mortgages for some social groups, notably those involved in the war effort, which further divides society into winners and losers.

Foreign investment could have mitigated some of this in better times, but it’s out of the question now. It might also be an option to increase the supply of workers from Central Asia, but with the war going on and anti-immigrant sentiments high, that’s also impossible.

The Kremlin, as a result, is in a three-way bind of its own making. The government can’t cut spending as long as the war continues. The war, however, saps the labor force, fueling inflation and diminishing both welfare and public sentiment. And high interest rates, necessitated by all that inflation, stifle investment in productivity and further distort the economy.

To be clear, Putin can keep this juggling act going for a while longer. Oil sales are keeping the budget sound enough (sales in April alone doubled to $14bn year-on-year), while military spending is still much lower as a share of GDP than in the USSR, and state capitalism remains much more efficient than late socialism. However, with every tick of the clock, Russia’s wartime economy becomes more susceptible to external (or internal, for that matter) shocks.

Putin used to know that the economy was best left to professionals. Indeed, the men and women running the country’s central bank, finance ministry, and ministry of economic development remain highly skilled and saved the country from economic collapse in 2022.

Two years on, they clearly understand the longer-term impossibility of the task they’ve been set. The question is, do they dare tell the boss? And if they do, will he listen?

Alexander Kolyandr is a researcher for the Centre for European Policy Analysis (CEPA) specializing in the Russian economy and politics. Previously he was a journalist for theWall Street Journaland a banker for Credit Suisse. He was born in Kharkiv, Ukraine, and lives in London.

Europe’s Edgeis CEPA’s online journal covering critical topics on the foreign policy docket across Europe and North America. All opinions are those of the author and do not necessarily represent the position or viewsof the institutions they representor the Center for European Policy Analysis.