The Russian Economy Is Like A Stool

Economist Sergei Aleksashenko has served as Russia’s deputy minister of finance (1993-1995) and as first deputy chairman of the Russian Central Bank (1995-1998). After subsequently working in the private sector, he returned to academia, heading macroeconomic research at Moscow’s Higher School of Economics and serving as a scholar in residence at the Carnegie Endowment for International Peace’s Moscow Center. His English-language publications include Putin’s Counterrevolution (Brookings Institution Press, 2018). He currently resides in the United States, where he works as an independent consultant and frequent commentator on the Russian economy. In this interview, which appeared on the Утро Февраля (February Morning) YouTube channel (utro02.tv), he discusses how the war and sanctions have impacted the Russian economy and explores future scenarios.

What sets the Putin economy apart from a normal economy?

There is the 2000-2008 Putin economy, the 2008-2013 one, the 2013-2015 one, and even a pre-2020 one. Then there’s the post-February 24 Putin economy. They are all different. The political regime has been changing, and its economy and economic policies have also been changing.

The Putin economy is normal in the sense that its basic prices are unregulated. The key difference between planned and market economies is how prices are set: in a market economy, the market sets them – supply and demand. Or prices can be set by a bureaucrat. In Russia, there is a sector where prices are regulated, and although it’s not very big, it’s important: that’s electricity, gas, and utilities. Sometimes a ceiling is placed on grain prices, and the price of petrol is regulated. But most prices are unregulated. If you put the American economy at one end of the spectrum and the Venezuelan or North Korean economy at the other, the Putin-era Russian economy would be markedly closer to the American economy than the Venezuelan or North Korean ones.

The Putin economy is normal from the standpoint of macroeconomic stability. Putin was head of the FSB during the financial crisis of 1998, and he remembers it well. He was appointed in July, and in August everything fell apart. And when he became president, he resolved: never again. So his macroeconomic policy has been sound, consistent, and aimed at limiting the deficit, at free-floating exchange rates – until February 24. But let me stipulate up front: “normal” macroeconomics doesn’t mean that the economy or economic policy is liberal. Saying two times two is four doesn’t make you an adherent of the Enlightenment.

Now, what sets Putin’s policies apart? As I see it, there are three main turning points.

The first, which was probably in harmony with the political trend, is that Putin took personal control of the largest companies, the biggest revenue generators, and transformed property rights in Russia, the right to hold large assets and usage rights. [Billionaire industrialist Oleg] Deripaska put it well in the Financial Times as far back as 2008: “If Putin tells me to give it back, I’ll give it back.”[note] As the owner of major assets, you can make a profit, you can spend those profits how and where you want, but if you want to sell something, you need Putin’s permission. If you want to create a joint enterprise with a foreign business, you need Putin’s permission. This is pivotal. To get this point through to all the oligarchs, Khodorkovsky was thrown in jail and Yukos was destroyed. Then there was Yevtushenkov and Bashneft, Goldovsky and Sibur, Gusinsky and Media-Most.[note] In other words, a signal was sent to the top business owners: “Guys, you can think whatever you want about yourselves – but not that you have full ownership rights.”

And so down the line. Putin got his cut, the head of his administration was eligible for his, as were the prime minister, the governor, the deputy governor, and so on. In short, the ability to deprive owners of their ownership rights was system wide. Courts were not prepared to defend ownership rights, and that fact is crucial to understanding Russia’s contemporary economic system.

Second, over 23 years Putin has concentrated essentially half of petroleum extraction, a key resource for the Russian economy, in government hands. And if you add Surgutneftegaz, that brings it to 60 percent. I have the feeling that Lukoil is in the process of being absorbed into the state ecosystem. Because [former Lukoil president Vagit] Alekperov and [former Lukoil chairman Leonid] Fedun have stepped down from the company’s board of directors, and the president has appointed his friend and comrade-in-arms [deputy chief of Putin’s staff, Sergei] Kiriyenko, and Kiriyenko is tied to [Putin’s childhood friend and fellow judo enthusiast, billionaire Arkady] Rotenberg. Clearly, the company is being run on the one hand by Kiriyenko and on the other – the behind-the-scenes beneficiary will be Rotenberg.

Under [Central Bank Governor Elvira] Naibullina, there’s been a consolidation of government property in the banking system. The Bank hasn’t been publishing its reports since February, but based on last year’s numbers, state banks’ capital and assets were more than 77 percent. So now, it’s about 80 percent. If you add 10 percent – that’s foreign banks – there’s nothing left for Russia’s private banks. If you put the entire banking system under the state, you control the flow of money. You (as the state) distribute the financial resources, and this is an important feature that sets the Putin economy apart from normal ones.

A third and crucial turning point was in September 2011, when Putin said “I’m not tired; I’ll be back.” This dampened any desire Russian businesses might have had to invest in development and the future. Since then, Putin has firmly believed everything good for the economy comes from the state and the only driver of economic growth is state investment.

This is why the idea of national projects began being pushed in 2012: the government’s task was to steer as much money as possible into investment, to convince businesses to also invest, and where they invested always had to be approved by the Kremlin. The policy of managed investment and investment at government expense became an important element of the Putin economy.

After February 24, everything changed. The economy and Putin’s economic policy both changed. I’d point to two main areas of change.

First, there’s the issue of Russia’s participation in the global economy. Even the sanctions imposed in response to the annexation of Crimea didn’t do serious damage to the Russian economy. Those sanctions coincided with a drop in oil prices, something the Russian economy endured in 1998, 2008, 2014, 2015, and 2020. That’s the Russian cycle. The American economy has one cycle, and we have another: the raw-materials-price cycle. During the 2014-2015 crisis, petroleum prices had a much greater impact than Western sanctions are having. After February 24, the Russian economic system made a quantum leap. It’s still leaping toward a new state that nobody can articulate.

I’ve used this comparison before: the current process is reminiscent of the transformation the Soviet economy underwent after the collapse of the Soviet Union, when everything unnecessary and inefficient fell away and the framework for a new economy took shape, one that was self-sufficient, stable, and capable of making a profit and developing muscle.

Now, it’s everything that tied Russia to the world’s developed economies that has fallen away. Not because those ties were unproductive. After the Soviet Union, it was things no longer needed or inefficient that fell away. It was inefficient to produce tanks. It was inefficient to produce color televisions, computers, VCRs. Producing Soviet automobiles wasn’t efficient. Now, it’s the most efficient parts that are being cut, the things that linked the Russian economy to the world economy. There’s still a link through raw materials: Russia is selling and will continue to sell raw materials. The world economy in its current form can’t survive without them. And technology was a unifying factor: tsarist Russia, the Soviet Union, post-Soviet Russia – none of them produced technology. They imported it. So the Russian economy is giving up technology – not voluntarily, but it’s being told: “That’s it. You’re not going to have that.” And how this process will play out, as in the 1990s, is unpredictable. Nobody knows how far this will go and how long it will last.

The second important change, from a macroeconomic standpoint, occurred when Nabiullina made the ruble a non-convertible currency. The dollar rate was no longer based on the supply/demand ratio, since demand was being artificially limited. Hard currency rates are a very important price in an economy and provide a certain equilibrium. And that undermines that very macroeconomic stability, the free movement of prices.

What has created the illusion of a strong and normal economy post-February 24?

I would distinguish between the illusion of strength and the illusion of normalcy. It’s not an illusion – the economy really is strong. The Russian economy is like a stool. It’s a very primitive but very sturdy design. It stands firmly on its legs. It takes petroleum, gas, metal, and timber from the earth, and it grows grain. It sells all that (plus fertilizer) on the world market. Taken together, they make up 85 percent of Russian exports. Harvesting all that requires a raw-materials industry. Exporting all that requires pipelines, railroads, and seaports. And all those operations require a banking system. Afterwards, the revenues are spent on everything the economy needs, what it doesn’t know how to make (or can’t make for objective reasons) – a quarter of the foodstuff market and half of the non-food market, key technologies, capital goods. That’s how it was pre-February 24.

Russia has a fairly stable agricultural sector, so it has a food industry. It has a postal, telephone, and telegraph system. It has a defense industry. If you take away metallurgy and the chemical processing of gases into fertilizer and the production of fertilizer, the entire manufacturing industry represents less than 10 percent of Russia’s GDP. Then there’s the government sector. Everything relies on raw materials: you get raw materials, you sell them, and you spend the money either on goods or by distributing it across the budget. So that stability isn’t illusory.

It’s important to look at the four serious crises that have taken place since 1996 – in 1998, 2008,
2014-2015, and 2020 – after the Soviet economy contracted into a coherent framework. Each of those crises was associated with a global decline in oil prices and demand for oil. In 1998, oil was plentiful, and you couldn’t sell it. In 2008 demand for oil fell – people didn’t need it. In other words, sudden changes and a sense of instability in the Russian economy arise only when oil prices and demand fall.

This crisis is different. On February 20, 2022, oil was $90 a barrel. It then rose to $120 a barrel. Now it’s gone down to $95. This is a perfectly comfortable price, and there’s no decline in demand for Russian or Arabian oil. Instead, Biden is sending his emissaries all over the world to get more oil. The Russian economy’s basic asset is oil – everyone needs it. Unless oil prices drop, there will be no sudden collapse of the Russian economy. No collapse should be expected until the West finds an effective and painless way of forgoing Russian oil.[note]

This is not to suggest the Russian economy won’t continue to contract. The economy will continue to shrink so long as it continues to shed elements tying it to the rest of the world. IKEA has left. IKEA’s sales equaled half of Russia’s furniture manufacturing. I realize that these figures are not comparable, since one is sales and the other is manufacturing. And IKEA isn’t just furniture. But it’s gone. McDonalds is gone. International flights are down to almost zero. The automobile industry is gone. Gas extraction is down 20 percent. There’s a ball bearing shortage, and the manufacture of freight cars has been cut by more than half. Steel and coal exports are both down 20 percent. The list goes on, and how long this process will continue, what it will look like, and will it go smoothly… Everyone remembers how, in childhood, you’d sit on a piece of cardboard and ride down an icy slope. You have no idea when and how the ride will end. So far, so good, but you keep sliding downward, and so long as nothing terrible happens, you feel you have things under control.

Leonid Bershidsky writes on Bloomberg that Putin is now a slave to the situation, and that the Kremlin’s planning is now reactive rather than strategic. That’s a very vulnerable position.

Putin has never been a strategic planner; he’s never had a strategic vision. His entire 23 years in power, he’s been solving tactical problems, reacting as the situation dictated. I’ve called this “The Mushroom-Hunter Effect.” You go into the forest to gather mushrooms, one leg has a longer stride than the other. And if you’re not careful, you’ll wind up walking in circles. Putin’s tactical actions are all based on very specific goals, specific principles and interests. And since he’s using a very specific system of coordinates, these actions form a logical chain. So we could say that he’s been moving the economy in a certain direction, since every time he makes a decision, he’s using the same logic. But even when he has tried to outline national projects, national development objectives, he’s failed to convey his vision for the Russia of the future. The contours of the future have been determined by the efforts of [First Deputy Prime Minister Andrey] Belousov and other members of the administration, who set the quantitative parameters, the way Gosplan used to do. “That indicator has to be increased to such-and-such, and this indicator has to be brought to this point, and this other to that,” but setting quantitative indicators is not the same as having a strategy. So I would agree with Bershidsky.

Now that pieces of the Russian economy are falling off, and not through Putin’s initiative but due to decisions taken by other countries, Putin must react more forcefully to external factors, and this makes the reactions more noticeable. But over the past 22 years, we didn’t really understand the basis for any given decision. We didn’t see the triggers.

Now we see them very clearly. Here’s a simple example: in 2002-2006, [former head of the state power monopoly Unified Energy System of Russia Anatoly] Chubais reorganized the UES company. As part of the reorganization, generating companies were spun off. There was a dream of attracting major foreign investors. They succeeded: an Italian one, Enel; a German one, E.ON (now it’s called Uniper); and a Finnish one, Fortum. Then came the war, and Enel and Fortum said: “We’re leaving. And we’re selling our shares.” A huge number of new projects had been carried out, and they had transformed their generating companies into some of the most efficient. They supplied equipment, they had committed to expanding capacity, to maintaining the equipment they installed. And now they were saying “We’re leaving, we’re selling.” We’re selling to Lukoil, we’re selling to Gazprombank. And Putin said: “No! You’re staying right here. And since you’re staying, nobody is relieving you of your obligation to maintain capacity. Or your commitment to build new generating capacity. If you don’t, you’ll pay fines. And the fines will be such that in the end you’ll lose everything, just as YUKOS did.” Here we see the trigger very clearly and understand why he issued that decree. And the effect that decree will have.

But in general, I repeat: Putin has always been solving tactical problems. He’s never had a strategy.

Staying with your metaphor of the stool and of casting off the superfluous, what epithet would you use to describe the contemporary Russian economy after February 24. An economy
of resistance?

It hasn’t changed. It’s an economy of oil, gas, pipelines, and metal. Think of a subsistence economy: I sell strawberries, which I grow with my own hands. I grow everything else I need and that’s what I live on. Today, there’s not a single country that lives that way, not even North Korea. As Adam Smith explained, countries should trade with one another, because that’s advantageous. The Russian economy, to Putin’s good fortune, is tied to the world economy through the supplying of raw materials; globally, it’s not integrated into any manufacturing process chains. There’s nothing to break down. The world economy can’t get by without Russian raw materials. So even now, the nature of the economy isn’t changing. It’s just that some of its sectors will disappear. Pepsi-Cola is gone; Coca-Cola is gone. Russia was and will continue to be a supplier of raw materials for the world economy. Through all those crises – 1998, 2008, and so on – the petroleum sector’s share of the economy has only grown. And this crisis will lead to raw materials growing as a share of the economy, since the raw-materials part is not going anywhere.

A portion of Ukraine has been captured. Not precious, unscathed Crimea, but bombed out territory that will need to be rebuilt. Russia is limited by sanctions. Reconstruction will come at a cost: people in Yakutia will have to forget about their bridge over the Lena. People in Ufa will have to forget about their sewage treatment plants. Will Russia be able to handle that?

First of all, up to February 20 I didn’t think there would be a war – it didn’t make sense. I believed that war would have nothing but downsides for Putin. For me, it was an utterly irrational act. For the first time, I can’t explain what he wants and what advantages he sees for Russia, for its future. What he’s prepared to see as a victory. The total capitulation of Ukraine? Sure – he could fight to a victorious conclusion. But I’m afraid that he won’t be able to allow that to happen. My answer to your question of whether Russia can handle an occupation of Kherson and Zaporizhzhiya Oblasts along with Donetsk and Lugansk is that it can. There won’t be any bridge over the Lena in Yakutia, and Bashkiria won’t have sewage treatment plants, but who asked the Yakuts or the Bashkirs whether we should seize Ukrainian territory? Nobody asked them or ever will. They have no say in the matter.

Second, we can’t see into the future, but we can make guesses. One scenario I could see would be Putin deciding to keep Donetsk and Lugansk but use Kherson and Zaporizhzhia as bargaining chips in peace negotiations. As a lever, as hostages. His favorite tactic is to take a hostage and then twist arms.

Putin has it in his head that “state investment is the economy’s engine.” So building is the simplest form of government investment. There’s this go-getter comrade by the name of [Deputy Prime Minister for Construction and Regional Policy Marat] Khusnullin. On the one hand, he’s a good manager, a Soviet-style director who can out-build anyone and force everyone to work. On the other, he’s a man with zero economic expertise who six months ago said to Putin at a meeting: “How can it be, Vladimir Vladimirovich? We allocated an additional 500 billion rubles from the budget for construction, but they keep raising the prices for metal, cement, sand, fixtures – for everything. Why did they raise these prices?” That’s why he’s in Putin’s good graces. Putin sees him as an effective manager, someone who’ll take responsibility for getting things done.

So if and when the Kremlin decides to rebuild the occupied part of Ukraine, a huge construction project will be launched that, with help from the Federal Statistics Service, will demonstrate Russia’s economic growth.

Crimea has a population of 2.2 million. Donetsk and Lugansk Oblasts together, and whatever else is left there, are approximately double that. According to my calculations, on average $5 billion per year has been spent on Crimea since 2014-2015. But that included a large investment component associated with the Crimean bridge, gas networks, roads, and so forth. Even if we assume [Donetsk and Lugansk oblasts] will need twice as much as Crimea – $10 billion per year – the Russian Federation’s annual budget is about $400 billion. Can Russia handle that? It can. And Yakutia won’t get its bridge, Bashkiria won’t get its sewage treatment plant, and [Moscow Mayor Sergei] Sobyanin will fix the roads every other year instead of every year. Putin can put together that $10 billion.

Kherson and Zaporozhzhia? Russia could handle that as well. The possibility of a guerrilla movement, if everything is being blown up and destroyed and if local officials are being killed, is another matter. It’s not clear how the occupiers would deal with that. But from an accounting standpoint, the answer to your question of whether or not Russia can handle that unfortunately is: yes it can.

A question about the last straw effect. When I read that the Otis Elevator Company had left Russia, I thought that might be the last straw. At what point will people say: “That’s it, Putin. Enough of your war. We’re sick and tired of it.”

They won’t say that. We have a very good historical example. In pre-1945 Germany, people didn’t tell Hitler “Enough.” Under dictatorships, most people are submissive, not ready to risk their lives even for the brightest of futures. And then we have the example of Venezuela, where, under the wise stewardship of Maduro and Chavez, the economy has shrunk by more than half, inflation has turned into hyperinflation, there’s nothing on the shelves, and basic goods are distributed by the army, without even ration cards. Still, during elections that are much freer than in Russia, most voters voted for Maduro.

When I look around, I see that cases where an economic crisis has led to a dictator’s downfall – maybe there have been two or three across the globe over the past 70 years. So I don’t think there will be any last straw breaking the camel’s back.

An economy is an amazingly resilient thing. An economy is the production and distribution of goods and services for the population. So long as you don’t beat it with a sledgehammer, it will grow. It might grow slowly, but it will grow. This is a natural phenomenon. To compare the economy to a cabbage: you buy a cabbage, and some of the leaves are wilted. You tear them off and are left with a fine-looking head. Here as well, at some point what’s left of the economy will be healthy, and then it will start to grow. It will grow at a rate of 1, 2, or 3 percent per annum. No, probably not 3, but it might reach 2.

Will the Western economies be able withstand their
own sanctions?

The Western economies aren’t all the same. There’s the American economy. Insofar as the United States didn’t have any serious economic ties to Russia, it isn’t much impacted by sanctions. Yes, the banking sector will suffer some losses, and there are some marginal importers-exporters. And sure, Apple, IBM, Microsoft won’t be selling their products in Russia. There will be some losses. But it wouldn’t be accurate to say that the Russian market was crucial to American corporations – even to Pepsi-Cola, Coca-Cola.

The American economy has suffered not because Russia started a war and American introduced sanctions, but due to internal reasons.

It’s different for Europe. They had significant ties with Russia. Most importantly, they have bound themselves to Russia through petroleum and coal, and untying those binds is very hard.

Putin is right in saying that Gazprom has been gradually depriving Europe of cheap gas, and cheap gas means electric power and cheap electric power means the chemical industry. In that regard, Europe has taken a hit, but this hit is not from sanctions – it’s from Putin’s petroleum war. The biggest problems are associated with the energy sector, with the urgent need to find new sources for gas and coal. All that will be more expensive and create price pressures. I think the Europeans understand that depending on Russia for oil and gas was a strategic error. With the exception, perhaps of Hungary’s premier, [Viktor] Orban, everyone understands that Putin is a capricious freak whose actions are unpredictable and who lies left and right and doesn’t keep his promises. I don’t know whether Europe is ready to totally stop using Russian gas or it will keep it at the 5 percent level as part of its energy balance, but they’re being forced to transition. That will take two or three years. Yes: maybe the European economy will suffer some decline. Will it survive? Of course.

What is Russia’s path forward under Putin? Will it follow in Iran’s footsteps?

I think that Iran is a likely scenario – somewhere between Iran and North Korea.

For several decades now, Iran has been under sanctions pressure, and it has realized that without the West, the country can’t solve the problems it faces. That deprives the political system of stability, which is why Iran is trying to use backdoors and arrange joint projects, why it actively seeks and exploits disagreements between Europe and America. Now, European companies are ready to work with Iran. Russia, as a more economically developed country, was ready to do something with Iran, including a nuclear power plant.

Putin has a maximum of 20 years of active life left. For biological reasons, he’ll be less cognitively nimble and increasingly immersed in a fantasy world – think Autumn of the Patriarch – and he won’t be able to appropriately assess the situation. He won’t be looking for a way out by restoring contact with the developed world but will continue down the path of escalation. Consequently, under Putin, nobody in Russia will do anything serious in the economy. China will sell to Russia, but it won’t invest in its technological foundation, in the modernization of its potential, not to mention that China sees a modernized Russia as an economic rival. If Russia were to modernize, it would be able to produce everything China produces and break into the very markets that China now dominates.

In summary, the only path forward for Russia is to rely on its own strengths, something Putin talks about openly. I don’t want to say that will look exactly like North Korea, but I think Iran is a very likely scenario.

This article originally appeared, in Russian, on Utro Fevralya.