What is happening in the Russian economy and will it collapse?

 

Russian authorities have created a two-circuit economic system in which resources are redistributed with the help of fiscal and monetary policy tools in favor of industries that serve the needs of the war against Ukraine. Because of this, the "civilian sector" of the economy of the Russian Federation experiences a lack of labor, investment, is exposed to high inflationary pressure and faces an increase in lending costs. The "boom-bust" cycle should lead to a strong slowdown of the Russian economy.

During the almost three years of war, assessments and forecasts of the Russian economy ranged from expectations of rapid collapse, passing through surprise at its resilience, to belief in its strength and subsequent rapid growth. However, extremes are not the best assistant for an objective view. That is why it is necessary to deal without emotion with the reasons for the current strong economic dynamics of the Russian Federation (the GDP growth forecast for this year is four percent) and the forecasts for the near future.

Growth of the Russian economy in the period 2023-2024. is based on the following factors:

 

- strong budget infusions into the enterprises of the military-industrial complex (MIC). Russian manufacturing statistics show that the drivers of growth are "finished metal products", "other vehicles" (ie non-civilian), "electronic and optical products";

- the large contribution of stocks to GDP growth, which are taken into account, including raw materials and materials for future military production and military products in unfinished production - that is, the economy of the Russian Federation largely "works on storage" and to a significant extent on military storage;

- the market nature of the links of the military-industrial complex with the rest of the economy leads to the outflow of part of the money from the military-industrial complex, its workers (as well as the families of military personnel) into

the market sectors, high incomes of workers of the military-industrial complex and related industries increase wages in the market sectors of the economy;

- an increase in private consumption against the backdrop of a sharp increase in wages in the military industry and related sectors (as well as high payments to military personnel);

- good dynamics in retail trade and housing construction, which is strongly stimulated by mortgage lending.

 

It should not be assumed that the authorities of the Russian Federation have problems with money. Thanks to the long-term surplus of the trade balance, as a result of high energy prices and the large volume of their exports, a reserve of financial strength was formed. Trade balance surplus of the Russian Federation in the period 2000-2021. it amounted to an average of 9.3 percent of GDP per year. In export-oriented countries such as Germany - 5.3 percent, Japan - 0.3 percent (however, it should be taken into account that the GDP of these countries is twice the GDP of the Russian Federation). Russia's trade balance remains in surplus even after the start of the war: 2022 - $332 billion, 2023 - $140 billion, forecast for 2024 - $135 billion.

But Russia has problems with resources - workers, production capital, technologies, the intensity of use of which is now at the limit. The proof is abnormally low unemployment (below 2.5 percent) in conditions of high inflation (officially 8.5 percent, according to alternative estimates - twice as high) and historically record utilization of production capacities (thanks to the military industry and related industries). Thanks to budget incentives, money is increasing, but there are no more goods for civilian needs. It is possible to increase the production of goods either by increasing labor productivity or by attracting new labor resources, but neither can and will not happen.

There are not enough funds, so the authorities of the Russian Federation are forced to distribute them. The increase in demand for resources in the military industry and related industries, which are paid for from the budget of the Russian Federation, takes away resources from other sectors, creating their deficit. Income growth in the military-industrial complex and related industries leads to an increase in demand for loans and acceleration of inflation. Whoever will not be able to pay at higher prices and higher credit rates will have to "leave the market", freeing up resources to be used by the Russian military industry. Thus, until recently, the strategy of structural transformation of the economy of the Russian Federation was based on the fact that a certain number of people and economic branches had to win economically - the military industry, its branches and those who work there. Now, in order to continue the war in Ukraine, the structural transformation of the Russian economy requires that a certain number of people and industries lose out economically - due to reduced credit and investment opportunities and, consequently, their incomes are taken away.

The Russian economy has been artificially accelerated due to budget incentives. This kind of stimulus can stimulate the economy for some time, but the state will not be able to maintain demand at the current level of intensity for a long time with its resources, especially as it leads to a large withdrawal of resources from the civil sector of the economy and households. As soon as the Russian state is forced to start reducing budget incentives, the economy will noticeably slow down. This is the standard boom-bust cycle that many economies experienced during the Keynesian craze of the 1960s and 1970s.

The most realistic scenario for the economy of the Russian Federation seems to be a slowdown in growth from 2025 to a naturally balanced level, on average for several years - one to 1.5 percent per year. In support of such a scenario, the forecasts of authoritative international institutions testify - the IMF predicts GDP growth of the Russian Federation of 1.3 percent for 2025, the World Bank predicts growth of 1.6 percent in 2025, and 1.1 percent in 2026.  

The Russian economy is now artificially jumping above its natural trend. A return to the trend is almost inevitable, therefore a significant slowdown in the economy of the Russian Federation is most likely to occur. If supported by a significant reduction in global energy prices and effective sanctions against Russia's "shadow" fleet, it will significantly reduce Russia's ability to finance the war against Ukraine.