Why Russia’s economy is booming despite sanctions

In June of this year, the US Treasury Department confidently headlined its Russia policy in a press release: “Treasury Department targets basic financial infrastructure,” it said. Over 300 new sanctions had been imposed. These included measures designed to prevent Russia’s arms and war industry from financing itself with the help of the two largest Russian state banks and the Moscow Stock Exchange. The EU has now passed its 14th package of sanctions against Russia.

The extent of the economic restrictions imposed by Western countries against Russia has reached unprecedented levels. Switzerland has also supported most of the EU sanctions.

Flourishing war industry

But this avalanche of sanctions has not achieved its goal of making it impossible for Russia to finance and continue its war against Ukraine. If official Russian statistics are to be believed (and indeed there is no indication that they are falsified on a large scale), the Russian economy has recovered quickly after a slight slump at the beginning of the war and is now growing faster than before.

According to the Institute for Emerging Markets of the Central Bank of Finland, the seasonally adjusted annual growth rate of Russia’s gross domestic product was 5.4% in the first quarter of 2024, while total investment rose by 14.5%. The unemployment rate has fallen to 2.6% – the lowest level since the global financial crisis.

Does this mean that Western sanctions were ineffective?

However, that would be a hasty conclusion. Behind Russia’s economic upturn lies the country’s structural transformation into a war economy. In addition, massive investments are being made in the construction of transport infrastructure in order to be able to sell Russian oil and gas more easily to Asia rather than to Europe.

A comparison of the development of war-related sectors (armaments, metal processing, production of electronic and optical equipment, transport) with Russia’s other industries shows how much the war in Ukraine is changing the Russian economy. These other sectors are growing very slowly. According to a new publication by the Center for Economic Policy Research, an economics-oriented think tank based in London, production volume within the war-related industrial sector has increased by around 60 percent since the outbreak of the war and has more than doubled since 2019.

As in the USA during World War II

This growth is being driven by huge government spending and investments to strengthen Russia’s war economy. According to the CEPR study, the Russian government expects spending to grow by 13% this year, with military spending (continuing to) rise by almost 70%. The latter category will then account for almost a third of the state budget.

However, the Russian state was not forced to issue war bonds as the USA did in World War II. Thanks in part to the high oil price, Russia was able to sell goods worth 240 billion dollars abroad in the first seven months of 2024. This was mainly oil and natural gas, three quarters of which went to Asia. This means that despite Western sanctions, Russia is so successful that it continues to generate trade surpluses.

The fact that Russia’s economy is currently booming is thanks to the war economy, which is running at full speed. Because many arms companies are located in otherwise structurally weak regions such as the Urals, unemployment there has also fallen to a record low.

Combined with the high salaries of soldiers from these regions, this has increased purchasing power. As a result, the inflation rate is rising again and is currently likely to be above 9%. Russia’s central bank recently raised its key interest rate to 18%. On average, however, wages have risen more than prices in recent years. This means that many working Russians can actually afford more than they could before Russia invaded Ukraine. In the big cities of Moscow and St. Petersburg, the war feels very far away. Residents who do not publicly express their political views and are not subject to repression for other reasons can spend their money in cafes and restaurants and enjoy the summer.

So is Russia invading Ukraine like the United States in World War II? Unlike Europe itself, America was largely not directly harmed in that war. The United States was still suffering from the effects of the Great Depression at the time. However, entry into World War II and the transition to a war economy that focused on the state-directed needs of the military led to a GDP increase of more than half between 1939 and 1945. The country’s unemployment rate fell from 14.6% to 1.9%, according to a publication by the Economic History Association. With an innovative industrial sector centered around the defense industry, the United States ultimately emerged from the war stronger.

Dangerous development with bleak prospects

However, it is unlikely that the devastating war in Ukraine will strengthen Russia in a similar way in the medium term for several reasons:

Unfortunately, neither the strong economic relations between Russia and Europe that existed before the war nor the extensive economic sanctions imposed by the West have been able to prevent Russia from waging its classic war of annihilation and attrition in Ukraine. Significantly more pressure on Putin’s team would probably only arise if Russia’s raw material revenues were to collapse.

This is not to say that Western sanctions have been completely ineffective. They have made it difficult for Russia to access Western markets and technology. They have weakened the country’s private sector and made it one-sidedly dependent on China. Without a radical turnaround, the country’s future prospects are becoming increasingly bleak. Even though the economy seems to be doing well today, Russia is using up its limited resources and repeating the old mistakes that once led to the collapse of the Soviet Union. Economically and technologically, the West is still far superior to Russia.

To effectively exploit these advantages, the West would only need to muster the courage to wage a targeted and coordinated war of economic attrition, as it once did under the leadership of US President Ronald Reagan.

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