Mad Russia is a Long Time Coming

Hopes that war and sanctions would undermine the Russian economy and that this would make Putin stop have long since dissipated. The price of economic sustainability is a refusal to develop, primarily technologically. But this will have an impact later, and for now, such a structure is capable of satisfying the Kremlin’s military needs for years. Worse, the economy has managed to switch to a military model, and even the cessation of war will only strengthen Russian militarism, so the world should prepare for a long confrontation with Putin’s aggressive Russia — this is the conclusion made by Sergey Aleksashenko, Vladislav Inozemtsev and Dmitry Nekrasov, co-founders of the CASE think tank, in their report Dictator's Reliable Rear.

This article is a retelling of the report.

Safety margin

The Russian economy was able to withstand the onslaught of sanctions thanks to the fact that it remained market-oriented, the world could not refuse Russian oil, and the West could not isolate Russia on the world stage, plus the professionalism of technocrats. Several misconceptions were dispelled at once, here are some of them.

The economy is state-owned and therefore inefficient. This thesis gained popularity as Putin gained control of the largest companies. It seemed that the stability of the Russian economy was like that of the Soviet economy. The notion of “efficient managers” was synonymous with corruption and incompetence. But private business provides almost half of employment (48%), and many state-controlled giants, such as banks, operate in a competitive field. Inozemtsev previously explained why Russia's economy is not like the Soviet economy.

The desire to adapt for the sake of survival was evident even after the 2014–2015 sanctions, and it was the main reason for its current resilience. And property, which many liberals saw as the basis for ensuring and expanding political liberties, has become the main reason for non-resistance to the authorities, since fears of losing it perfectly disciplined the Russian entrepreneurs (IStories reported about how business accepted the war).

A gas station masquerading as a country. Many saw the raw material specialization of the Russian economy as a weakness, but it ignored that despite the unpretentiousness of gas station business, everyone has to visit the place a couple of times a week.

After the outbreak of war, it turned out that Russia could not be excluded from the global commodities trade — otherwise prices for oil, gas, metals and more would skyrocket. U.S. President Joe Biden spoke of “Putin’s inflation” not without reason.

That is why Russian raw materials, despite all the sanctions, have easily found their way to the world market if offered at a discount price. Russian exports decreased from $491.6 billion in 202139 to $425.1 billion in 202340, or by a mere 13.5% (comparisons with a very special 2022 should be avoided), and will probably remain close to that level in 2024-2025, providing the opportunity both to cover all necessary imports and to balance the federal budget.

The West decides everything. The degree of openness of the world economy was also underestimated. It turned out soon that Western countries’ role is not decisive in Russia’s foreign trade and in its financial transactions. Despite the energy embargo introduced by the West, and the sanctions imposed on all the basic sectors of the Russian economy, Russian business appeared able to redirect commodity flows to new markets and find new suppliers of many of the products it needed. In addition, officials and businessmen cooperated in inventing smart schemes for circumventing sanctions (like the famous “shadow fleet”) as well as in managing trade settlements in “non-traditional” currencies and barter deals.

Not enough money. Russia’s domestic capacity to stimulate demand was clearly underestimated. The authorities ensured a multiple increase in expenditures for the purchase of products from the military-industrial complex. For the first time since the end of the 17th century, a mercenary army has been created in Russia, with wages paid to the soldiers that are several times higher than the national average. The subsidized mortgage scheme launched during the COVID-19 pandemic that was supposed to end in 2021, was extended until mid-2024, raising up to 6 trillion rubles in the construction sector. Mobilization and emigration created a deficit in the labor market, leading to a serious increase in wages and the purchasing power of millions of families.

The boom in household incomes — which will grow by 17.5% in real terms between 2022 and 2024 after seven years of decline — was the most unexpected phenomenon of the first war years: traditionally, in Russia, wars had led to a decline in living standards.

A delayed blow

Although the economy is resilient, it would be untrue to say that the sanctions have not caused any crisis in it.

Inflation. This is the new normal for the Russian economy that keeps it in a state of equilibrium. The Central Bank fights it by raising the interest rate, but this policy is ineffective, since the causes of accelerated price growth are beyond its control (IStories told about it). Besides, the high rate restrains economic growth.

So far the Central Bank manages to keep inflation in check, but the experience of many countries shows that inflation accumulates its potential for a long time and at some point it is rapidly realized.

Degradation. Expected GDP growth of around 4% this year will cause euphoria in the Kremlin and surprise in the West. The expected slowdown (to 2.6% in 2025, according to the Ministry of Economic Development’s forecast) is unlikely to upset Putin much, since he will be able to argue that this is still better than in “unfriendly” Europe. 

The expected GDP growth of 3.8-4% in 2024 will likely trigger euphoria in the Kremlin and surprise in the West. The anticipated slowdown to 3% in 2025 and 2.5% in 2026 is unlikely to disappoint Putin,as he can still claim it is better than the performance of “unfriendly” Europe. However, a quantitative increase in the production of long-established products through more intensive use of existing equipment, expansion of services and limited modernization of infrastructure, which are not accompanied by technological progress. It is crucial to recognize that, in qualitative terms, the Russian economy is slowly degrading and falling behind in technological development relative to “unfriendly” countries and “friendly” China. Traditionally, new technologies and innovations came to Russia with Western investors, which can now be forgotten.

The Kremlin’s hopes for “pivoting to the East” are not being realized in any substantial direct investment or modern equipment supplies from China (they are minimal). Even in sectors where Chinese companies could potentially enhance the current technological level of Russian industry, such as mobile communications or electronics, imports from China are barely noticeable, as Chinese companies fear secondary sanctions. This scenario does not necessarily imply a sharp economic slowdown, but in the long term it points to Russia falling out of the mainstream technological trends, which will be the main economic cost of the current war.

Everyone is happy

All of this will have an impact sometime later, but for now it poses no threat. In warring countries — especially in those whose territory is almost untouched by the fight — militarization may not provoke serious problems for quite a long time. Russia learned to live with sanctions, military spending became a serious support, and in 2023–2024 war began to be perceived as a background process not only in the public consciousness, but also in economic life. The new model turned out to be not just sustainable, but also favorable for the majority.

A significant part of both individuals and businesses does not experience profound economic discomfort either from Putin’s aggression against Ukraine or from the Western nations’ reaction to it — the main effect of sanctions has so far been felt by the upper middle class, which has historically taken the most critical stance against Putin. At the same time, military payments have increased incomes in depressed regions.

And this is after a long period of stagnation, when real incomes were slowly declining (IStories reported about the decade lost to the economy), and a significant part of society had virtually lost hope for growth in prosperity. The main desire was to maintain the notorious stability (according to the wish “it couldn’t get any worse”). This contrast and banal economic considerations, no less than Putin's propaganda, have determined the attitude of Russians to what is happening. The visible improvement in the economic situation felt by a large part of the population (without it getting worse for a significant number of Russian families) against the background of the aggravated “geopolitical tensions” looks like a miracle.

A significant reduction in imports originating from Europe stimulated the development of businesses focused on domestic demand. Although it can hardly be called “import substitution” in the sense that Russia began to produce analogues of previously imported products (when they appear, then of much lower quality and at prices several times higher than the cost of the originals), this is of no importance for assessing economic dynamics.

Many people benefited from the change in the structure of budget expenditures in favor of purchases of domestic goods and services (weapons, ammunition, military uniforms, and transportation services) — the so-called fiscal multiplier (a ruble spent stimulates many others to spend as well) increased noticeably. The same was the effect of payments to mobilized and contract workers, the vast majority of whom are residents of depressed regions. Their families, having received additional income, were primarily concerned with improving the quality of their diet and purchasing essential goods, most of which were produced domestically. Such budget expenditures not only stimulated domestic demand, but also brought additional tax revenues to the budget a few months later.

The population perceives inflation “with understanding,” and it helps the authorities to fill the budget.

Why it lasts

During 2023, a set of mechanisms emerged that allowed the “war economy” to deliver impressive results, and in 2024 it showed itself even better. And even if the war stops, this mechanism cannot be reversed.

The planned increase in military spending in the 2025–2027 budget does not necessarily indicate that Putin intends to continue the war for the next three years — no one knows that, not even he himself. But if the war ends, we should not expect a drastic reduction in military spending. The Ministry of Defense will need to replenish its stock of military equipment, weapons, and ammunition — Putin has warned that the defense industry will remain overloaded with orders for many years to come.

By the end of 2024, the Russian authorities had lost any fear of negative economic trends that could develop in connection with the war. The government determined both the sources of economic growth and budget revenues, as well as possible options for saving resources that do not undermine either political or social stability. The budget for 2025 and for the next few years provides a clear signal that the Kremlin is ready for a prolonged confrontation with the West while maintaining the current level of military spending — and, most likely, is rationally assessing its capabilities.

Even if the Russian authorities do not consider the current situation optimal, they have no doubts about their victory. This is precisely why they put forward such preconditions for the start of peace talks that are unacceptable for the Ukrainian side, why they deliver militaristic economic priorities for 2025–2027, and why a new increase in the number of servicemen in the Russian army was recently announced. Thus, Vladimir Putin demonstrates that from his point of view, military burden on the Russian economy looks moderate, and economic factors are not too significant for making political decisions. Putin demonstrates that economic factors are not important in political decision-making. The economy allows the Kremlin to continue the fight.

The scale and nature of the changes that have occurred in the Russian economy make one believe that the end of full-scale hostilities will not restore a pre-war “normality”. More than 10 years ago, when Vladimir Putin finally abandoned attempts to integrate his country into the global “golden billion” and turned toward military resolutions of geopolitical problems, the Russian economy has changed radically. 

Today, it has become accustomed to rely heavily on domestic resources and cut ties with the most developed part of the global economy; it is dependent on military spending, which has more than doubled as a share of GDP; almost all the most “globalized” representatives of the entrepreneurial class are effectively “put under house arrest” in Russia; property rights have largely been nullified and are determined exclusively by Putin’s decisions; the purchase and sale of human life for “disposal” has become a normal phenomenon that does not contradict the new public morality. Aspects of society’s life related to education and the formation of value systems have changed significantly.

Even if the war stops, the new Russian militarism will not disappear — and moreover, it will likely even strengthen under the influence of propaganda triumphantly describing Russia’s “great military victory”. Some reduction in military spending after the end of hostilities, that might include a sharp decrease in death gratuities and injury compensations, could bring the overall military allocations down from 6.5 to 5-5.5% of GDP, but this will make the budget more robust and provide the Kremlin with additional opportunities. 

After some intermission, military spending may grow again — the economy looks ready to support the existing system and there is no reason to believe that Russia will collapse from its militarism. Without a regime change, Russia will not turn back into “a normal country.”

A game without rules

So 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.

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.

“Parallel imports” have allowed Russian firms to bring thousands of non-certified products into the country without the manufacturer’s consent. However, dealings with Russia had proven so profitable for Western companies that, on the one hand, few of them have left the Russian market for good, and, on the other hand, most of those that have formally left it have not offered ways and means to prevent Russian consumers from using their products (and sometimes even stimulate their presence on the market).

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. This creates a trend that is alarming for the West and highly significant for Russia: Russia is not simply “falling into China’s embrace” — it is is transforming into a center of an “alternative model of globalization,” operating outside the frameworks of Western-controlled institutions and established rules.

It is quite possible that in the near future the Russian business, with the support of the Kremlin, will try to launch original settlement systems based on the use of cryptocurrencies or other instruments that will no longer be vulnerable to “traditional” banking sanctions.

This trend could prove far more dangerous than the much-discussed “export of corruption” (to work in a corrupt country, you have to play by its rules): it is explicitly aimed at undermining the Western-led world order rather than integrating into it. As recent years have shown, the use of unconventional payment systems, the export of pirated products, and the smuggling of goods from Western companies — all of these practices are much easier to implement than previously assumed. 

This “rule-free trade” is still burdened by significant transaction costs (such as processing banking payments under the sanctions regime). Still, these costs are likely to decrease as alternative payment systems are developed. Even intense pressure from the United States has not led to a collapse in Russia’s trade with China, although it has made it more difficult.

Viewing all of this as merely a way to circumvent sanctions is extremely shortsighted, as the Kremlin has set its sights on fundamentally undermining the existing system and has reasonable grounds for hoping to succeed. This makes it possible to attract a number of countries and political leaders who are unhappy with Western dominance over global rules and institutions and who believe that rejecting them could yield positive outcomes. And this is another important basis for Russia’s economic resilience.

Over the past century, Western democracies have faced dictatorships twice — once the Fascist regimes, another time the Communist ones. In the first case, the confrontation spiraled into a global military conflict, while in the second case it was avoided by winning the economic competition. The West should not count on a repeat of the second scenario. Russia is still too far from the level of military spending reached by the Soviet Union during the Cold War and has a market economy.

It is futile to ramp up sanctions. Russia’s economy has adapted to them, there is practically nowhere to strengthen them, and it is fraught with undesirable consequences for the West itself as it provokes the buildup of political alliances in other parts of the world that advocate a revision of the “rules of the game” that were adopted after the collapse of the Soviet Union. Yes, restrictions on the use of modern technology and intellectual capital developed by Western nations are firmly holding back Russia’s modernization, but we should not expect this to cause serious damage to its economy in the next two or three years. Most likely, the main effects will become apparent over a much longer term and will challenge not Putin’s Russia, but the country that will struggle to return to normalcy after he is gone.