Power plant for Lukoil’s refinery in Volgograd, Russia. The Moscow-based company is one of the world’s largest publicly traded, vertically integrated oil and gas companies, with over 100,000 employees, and refines over 1.2 million barrels per day. Press release image, courtesy of Lukoil.

Russia’s economy is much more than a “big gas station.” Under sanctions, that’s now its biggest problem.

By Janis Kluge, November 9, 2022

https://thebulletin.org/wp-content/uploads/2022/10/Lukoil-150x150.jpeg

Power plant for Lukoil’s refinery in Volgograd, Russia. The Moscow-based company is one of the world’s largest publicly traded, vertically integrated oil and gas companies, with over 100,000 employees, and refines over 1.2 million barrels per day. Press release image, courtesy of Lukoil.

Western accounts of the Russian economy are quite often a little cartoonish and simplistic. Russia is regularly characterized as a “petrostate” that does little more than extract minerals and sell them abroad in exchange for consumer goods—or, to quote John McCain: “Russia is a gas station masquerading as a country” (CNN 2014). (McCain made this comment during an interview with the press during Putin’s 2014 annexation of Crimea, and this characterization seems to have caught on, being used by everyone from journalists to Harvard economists [Cohen and Ewing 2022].)

In reality, however, Russia’s economy is more diversified, modern, and internationally integrated than is commonly thought. Despite Russia’s long-standing problems with corruption, red tape, and a dominant oil and gas industry, modern manufacturing and services industries have developed in Russia in the last 20 years—often with the help of Western knowhow and capital.

And therein lies the rub. Under sanctions, the complexity and international integration of the Russian economy is now its biggest problem: Western investors and high-tech have made Russia richer and more modern, but also more vulnerable. Western sanctions are targeting these vulnerabilities by focusing on Russia’s access to technology imports and its financial system. As a result, Russia is now locked out from vital supply chains as well as the most important international capital markets. And that is where its economy is hurting.

The internationally connected sectors of Russia’s economy are the ones that are currently suffering the most from Western sanctions. They have been felt the strongest in Russia’s automotive industry, which was mostly run by Western manufacturers such as Renault, Volkswagen, and Mercedes. This sector cranked out over 1 million cars in 2021, but it has almost come to a complete standstill in recent months, after Western firms left the country (Reuters 2022).

The situation is similar in Russian aviation, the locomotive industry, or the production of electric appliances. Russia’s IT industry, which had been growing in recent years, is taking a hit as well, with scores of programmers leaving the country (Faiola 2022) and international companies shuttering their Russian development centers (Moscow Times 2022).

In comparison, the “gas station” part of Russia’s economy remains relatively unscathed by Western sanctions. True, Russian oil exporters have to offer their crude with a discount to find willing buyers, but their production and export volumes have hardly changed (Perkins 2022). This is not because the West does not have the instruments to sanction Russian exports. For example, Washington could implement Iran-style oil sanctions against Russia—i.e., threaten secondary sanctions against buyers of Russian crude.

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However, the truth is that the West currently does not want to further limit Russian exports, because it would take more oil off of the world market and increase already high gasoline prices. The West’s dependency on oil means that Russia’s energy exports can only be reduced gradually over a span of several years, to give alternative suppliers the chance to expand and take over Russian market shares. The proposed price cap on Russian oil sounds like an attractive alternative to export sanctions, but its effectiveness is still uncertain.

Oil exports are also saving the Russian budget—for now. Russia’s Finance Ministry drastically increased spending in 2022 to cushion the sanctions’ effects on the economy. Spending on Russia’s military has skyrocketed as well, judging by the little data that is publicly available. As a result, the budget balance deteriorated in recent months, leading to a significant deficit in the month of July.

But Russia’s government will not run out of money anytime soon. It still has several options to mobilize additional resources: It could reshuffle spending from long-term investments (e.g., building schools or roads in Russia) to more urgent needs (the war in Ukraine). Public debt is also low and the Russian Finance Ministry has plans to borrow more domestically and to some degree on Chinese capital markets.

Finally, there is always the option of simply printing more rubles, which would lead to higher inflation eventually, but could keep the state’s finances above water for a few years.

For now, the budget revenue will most likely suffice to pay for the survival of Putin’s regime. But it cannot prevent Russia’s economy from deteriorating. The Russian Economy Ministry estimates that Russia’s GDP will contract by 4.2 percent in 2022 and another 2.7 percent in 2023. The annual GDP numbers may look small, but they imply a decline of Russia’s monthly GDP of around 10 percent from February (pre-sanctions) to December 2022. (All quantitative estimates of Russia’s economic future are fraught with very high uncertainty, because there is simply no precedent for the sanctions imposed against Russia. The numbers could still turn out to be much worse, but also more benign.)

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While it is difficult to predict the speed and ultimately the depth of Russia’s economic decline, there is little doubt about how the structure of Russia’s economy will change in the long term: Russia will inevitably become technologically more primitive, less internationally integrated, and less productive. The effects of sanctions are asymmetric, because some sectors of the economy are more resilient than others. The relative importance of the natural resource exports for Russia’s economy will increase, even if the extractive industry could shrink in absolute terms in the next years, simply because it is less affected than other sectors. Similarly, agriculture and basic services such as retail trade can be expected to have a future despite sanctions.

For Russia’s manufacturing and advanced services, such as the IT sector, the outlook is bleak. The government may try to prolong the lifetime of factories, especially those in Russia’s many Soviet-era, single-industry “monotowns,” by erecting ever higher trade barriers and paying large subsidies, but the business case for large-scale production of sophisticated goods in Russia is gone. Manufacturing will of course not disappear completely and it will be a long erosion rather than an implosion—but without access to advanced machinery, software, and components, it will be difficult to sustain production in the long run, let alone modernize to keep up with other economies.

Russia hopes to find new partners to replace technological cooperation with Western companies. It also wants to replace direct deliveries of Western goods with unlicensed so-called “parallel imports” through third countries. But these replacements are unlikely to improve the picture dramatically. Parallel imports may keep the illusion of normalcy alive for some rich consumers, but it is no solution for manufacturing at scale. Substituting imports with domestic production will only lead to very limited success, because no economy in the world can replace all the needed components and machinery for cutting-edge supply chains at once.

Eventually, Russia will produce less itself, and instead import more finished goods from willing exporters, paying for these goods by exporting fossil fuels, metals, and agricultural products in return.

Ironically, because of sanctions, the characterization of Russia as a “petrostate” or a “big gas station” will actually become much more true in the future.

References

CNN. 2014. “McCain: Russia a ‘gas station.’ ” CNN Politics Live Interview with Candy Crowley, March 16. https://edition.cnn.com/videos/politics/2014/03/16/sotu-sot-mccain-ukraine-a-gas-station.cnn.

Cohen, P., and Ewing, J. 2022. “What’s at Stake for the Global Economy as Conflict Looms in Ukraine.” New York Times. February. https://www.nytimes.com/2022/02/21/business/economy/ukraine-russia-economy.html.

Faiola, A. 2022. “Mass flight of tech workers turns Russian IT into another casualty of war.” Washington Post. May 1. https://www.washingtonpost.com/world/2022/05/01/russia-tech-exodus-ukraine-war/.

Moscow Times. 2022. “Deutsche Bank Moves Hundreds of IT Workers from Russia to Germany.” June 7. https://www.themoscowtimes.com/2022/06/07/deutsche-bank-moves-hundreds-of-workers-from-russia-to-germany-ft-a77922.

Perkins, R. 2022. “Russia seaborne oil exports at 3-year highs despite sanctions shake-up.” S&P Global Commodity Insights. June 16. https://www.spglobal.com/commodityinsights/en/market-insights/latest-news/oil/061522-russia-seaborne-oil-exports-at-3-year-highs-despite-sanctions-shake-up.

Reuters. 2022. “Russian car production suffers record 96.7% slump in May.” June 29. https://www.reuters.com/article/russia-auto-idUSS8N2V30IK.

As the Russian invasion of Ukraine shows, nuclear threats are real, present, and dangerous

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Jenny Agutter fan
Jenny Agutter fan
20 days ago

For once I’d like to see a Russian politician call for moving the RF to solar energy. Of course, we’re probably more likely to see the Duma repeal the anti-LGBT laws.