When Vladimir Putin took over the Russian presidency in 2000, he inherited a nation that was having trouble carrying out the most basic functions of a state. Putin found himself presiding over a multitude of crises: rampant crime, a major mortality crisis, a decrepit military, and an economy that had been devastated by Shock Therapy and corrupt schemes to sell off Soviet era assets to a small group of ruthless and well-connected bandits who became the oligarchs. As a result, Russians had experienced massive poverty, bouts of hyperinflation, collapsed savings, and the irregular payment of wages and pensions.
During his first term in office, one of Putin’s top priorities was to increase state revenues. This meant he had to get Russians to pay taxes. The tax system was complicated, oligarchs resorted to a myriad of schemes – legal and illegal – to evade obligations while the majority of Russians were too poor to pay excessive taxes. First, he implemented a reduced, flat tax of 13 percent for most Russians and a reduced corporate tax rate. Second, he presented the oligarchs with his famous deal: in order to keep their ill-gotten gains, they had to pay taxes and stay out of politics. The latter requirement effectively stripped them of being oligarchs and rendered them merely super-rich.
These policies worked and the state began to have more money in its coffers. It helped that the price of oil was high in those years and Russia invested in improving its oil infrastructure. Putin also implemented a land code that allowed for the buying and selling of residential property. Since many Russians had been given deeds of ownership to the apartments they lived in during the 90’s, they could now sell them as assets.
Another priority for Putin was to pay off all of Russia’s sovereign debt. By 2003, Moscow paid off its debt to the IMF and by 2006 it paid off the Paris Club. Today, Russia has very little sovereign debt and continues to pay what it owes on foreign bonds, despite roadblocks being thrown up by the west.
By 2007-2008, Russia was seeing an average annual GDP growth rate of 7 percent. Many Russians wanted the Kremlin to use the extra income it was getting from oil sales to increase spending. But Putin and his advisers knew that the price of oil could vacillate and they needed a plan for years when the price would be low and income for the budget would decrease. A reserve fund was established and billions of rubles were saved.
Between 2001 and 2010, the poverty rate was cut from 35 percent to 10 percent while the size of the middle class expanded from 30 percent to 60 percent, driven by wage growth and an increase in the availability of more productive jobs. However, though Russia has universal health care and education, public spending on the welfare state is stingy compared to the EU average.
Russia’s Response to the 2014 Sanctions
Putin has prioritized stability and many Russians, given their history of constant upheavals over the past 100 plus years, especially the collapse of the 90’s, largely agree with that priority. Keeping taxes low so that the citizenry doesn’t become motivated to ask too many probing questions about where its money is going, along with a low unemployment rate, has comprised a large part of the Kremlin’s strategy for maintaining stability, especially in the face of stagnating incomes since 2014.
Over the past 8 years, the unemployment rate has been between 4.6 percent and 6.0 percent. In March of this year, the unemployment rate was 4.1 percent and is expected to be around 5.3 percent for the end of Quarter 1 due to most western companies leaving the country and other effects of the extreme sanctions levied by the US/EU since February.
The import substitution policies that were enabled by the counter-sanctions the Putin government imposed on western food imports in 2014 has led to Russia becoming self-sufficient in food and the top exporter of wheat. Just prior to the counter-sanctions, according to the UN, Russia was already in the top 3 of producers of many fruits and vegetables as well as potatoes and poultry. By 2015, the Russian government was providing federal budget funding and legal/regulatory frameworks and facilitating loans to support import substitution. In 2017, Putin announced a public goal of becoming the world’s top producer of organic produce. Legislation creating official organic standards and labeling and certification procedures was signed in 2018.
During that period, it also began to diversify its trade relations, mainly with China, India, Vietnam, Turkey and Latin America. China is now Russia’s largest trading partner and the Russian-led Eurasian Economic Union (EEU) is a major partner in China’s Belt and Road Initiative. The EEU also has a free trade agreement with Iran.
Russia’s Response to the 2022 Sanctions
According to University of Birmingham professor Richard Connolly in his book, Russia’s Response to Sanctions, as of 2018, Russia’s economy could be roughly divided into four sectors. The first is Sector A, comprised of highly profitable companies that are competitive on the global market such as fossil fuel companies, agricultural conglomerates, some defense manufacturers, and companies involved in commodities. The state plays an important role in these companies either through ownership stakes (e.g. Gazprom and Rosneft) or via strong personal ties between the political class and the owners (e.g. Lukoil).
When it comes to commodities, Russia’s role in the global economy cannot be understated and fossil fuels is only a part of it. Russia is the #1 exporter of gas, #2 exporter of oil, #3 exporter of coal, #1 producer of enriched uranium, a key exporter of all three components of fertilizer, #2 exporter of sunflower/safflower oil, the #1 exporter of wheat, and a major exporter of aluminum, steel, and various metals needed for electronics and airplane manufacturing.
Second is Sector B which consists of companies that mostly provide domestic goods and services, such as auto manufacturing, shipbuilding, and fossil fuel equipment. Businesses in this sector don’t always produce a consistent profit and are not typically competitive globally. They are dependent upon the revenue produced by Sector A. Pensioners and government workers are also included here. It’s estimated that sectors A and B combined account for around 70 percent of the Russian economy.
Third is Sector C, which is the sector comprised of companies that rely on their ability to make a profit and are more likely to encourage competition and innovation. These include large construction companies, retail and business services, various small and medium sized businesses in retail, transportation, business support, and communication technology.
Fourth is Sector D which is Russia’s financial system. It consists mostly of large state-owned or influenced banks that provide a wide range of services and credit mostly to sectors A and B. Russia’s financial sector is relatively small compared to other middle-income countries.
Russia’s Economic Support Measures After Post-Invasion Sanctions
Russia’s political class certainly realized that major economic sanctions from the west would result from its invasion of Ukraine as both the Biden administration and various European leaders had warned. However, it appears that the freeze of nearly half of Russia’s foreign currency reserves, consisting of dollars and euros, took the Kremlin by surprise.
In addition, western companies fled or suspended operations in droves in the weeks after the invasion. In response, the Russian Central Bank (CBR) enacted several emergency measures that included closing the Russian stock market for weeks, increasing the interest rate to 20 percent to counter inflation (it has now been lowered to 14 percent), and capital controls, among others.
The Kremlin has also passed more than one tranche of government bills to provide support to individuals and businesses. The first package included the allowance for pensions and the minimum wage to be increased. It also provided for various methods of increasing the domestic supply of medications including export restrictions and pausing inspections on businesses through the end of the year.
Subsequent bills have included extended government support for families with children under the age of 16, the restructuring of regional government debt, and providing loans from the federal budget to support regional economic development.
A policy allowing for parallel imports, or a gray market, was also announced earlier this month. Products listed for parallel import mostly consisted of western automobiles and their component parts such as tires, metals, tools, electronics, and seat belts. This was likely motivated by the 79 percent drop in automobile sales and the simultaneous rise of 31 percent for auto parts in April.
Inflation is high for big ticket items while the price of food is starting to stabilize and grocery stores are reportedly well stocked. A recent shortage of sugar has now abated thanks to sugar imports from Brazil, but there have been reports of shortages of feminine hygiene products, paper and disposable gloves. Energy consumption is holding up as well as consumer spending in bars, cafes and restaurants.
Russia still has high revenues, approximating $1 billion a day, coming in from energy exports due to high prices. Despite tough talk from the EU about a ban on Russian oil this year, Hungary’s concern for the potential catastrophic effects on its economy has forced the idea onto the back burner. Again, despite tough rhetoric rejecting Russia’s gas-for-rubles scheme, five countries have now agreed to open up the necessary accounts with Gazprom, including Germany, Austria, Italy, Hungary, and Slovakia.
Russia is also enjoying a record trade surplus as exports have increased by 8 percent and imports (mostly from the west) have decreased by 44 percent And, according to Bloomberg, as of May 11th, the ruble was the world’s best performing currency this year.
As for the long-term effect of western businesses leaving Russia, it was just announced that Russian businessman Alexander Govor is set to buy all 850 McDonalds’ restaurants in the country and will operate them under a new name. According to ABC News: “Govor, a licensee since 2015, has also agreed to retain McDonald’s 62,000 Russian employees for at least two years on equivalent terms. Govor also agreed to pay the salaries of McDonald’s corporate employees until the sale closes.”
This is not to suggest that the Russian economy doesn’t still face significant challenges. There is a projected loss in economic growth of 10.4 percent this year, supply chain issues are expected to hit early next year, personal and business savings have dropped, and unemployment has edged up. But clearly the objective of collapsing the Russian economy has failed and for largely the same reasons that I have outlined in previous writings about the western sanctions of 2014.
This is the result of western countries having no substantive understanding of Russia and rather than learn from past mistakes in prognosticating the effect of their policies, they seem to revel in continuing on with their ignorance. Though Russia does have significant problems such as corruption, lower productivity, and a smaller financial sector than many other middle-income countries, it clearly would not be able to show the wherewithal it has if it were merely a kleptocracy or a gas station posing as a country.