Russia should know that an over-extended military can break its economy

Andrew Lilico

One key question about the Russo-Ukraine War is: how long can the Russian economy keep it up? After all, the intention of Western economic and financial sanctions against Russia was to cripple Russian growth and render its war machine incapable of maintaining the fight. At one level this might not seem that hard. The Russian economy isn’t in the world top ten largest – on IMF figures it sits between Canada and Mexico in size, and is only just over half the size of the UK’s. Indeed, sanctions did have a very marked effect.
Russian inflation spiked up in early 2022, just after the war began, from under 10 percent to around 18 percent, partly because cheap imports vanished or became difficult to obtain. Interest rates rose from under 10 percent to 20 percent in response. Russian GDP, which in 2021 had been bouncing back from Covid, then contracted rapidly through the rest of 2022. Russia’s heavily-oil-dependent economy is estimated to have lost over $100 billion as a consequence of oil sanctions.
Yet economies at war often find a way to keep going for longer than one might think, provided that domestic citizens retain faith in their leaders – as opinion polls (perhaps surprisingly) suggest Russians continue to do. Russia has greatly raised its military spending, up from around 4 percent of GDP prior to the war to 6 percent next year. In the short term, such a large rise in spending is boosting Russian economy activity. According to the Carnegie Endowment for International Peace, there is rapid growth in Russia’s defence-related sectors such as transport (up 66.7 percent), computers and electronics (up 42.6 percent) and navigation devices (up 72.4 percent).
Recent oil price rises have also helped the Russian economy, as despite Western restrictions on the handling of oil bought from Russia at more than $60 per barrel, recent international prices markedly above that have increased Russia’s scope to evade. The current violent attacks by Hamas on Israel may even have had, as one of their goals, a rise in oil prices – after all, Russia is a significant Hamas backer. Yet, eventually, the economic effects of sanctions and war will be very negative for Russia. Some military spending does boost GDP.
At the most basic level, a country that has no military will suffer the predations of neighbouring country invasions, bandits, pirates and domestic insurrections without being able to respond. Additional spending can also help with protecting trade, extending cultural links, inculcating a societal sense of mission that directs innovation, and through various other mechanisms. But these effects top out, and beyond them there is a significant cost.
Academic estimates of the impacts of raised military spending suggest that economic growth can drop by nearly a tenth for every additional 1 percent rise in military spending. Russia has had a 50 percent rise. Prior to that, Russian economic growth was more than 5 percent per year. So if those academic results apply this time and the Russo-Ukraine War is sustained, we might eventually expect the Russian economy to contract by 20 to 25 percent.
Russians have recent experience of military over-extension leading to economic collapse. The late-era Soviet Union spent around 12 to 17 per cent of GDP on its military in the 1980s, as the arms race with the US and the war in Afghanistan drained its economy, eventually to the point of collapse. Russian military spending is not yet at that level, but if the war drags on and additional mobilisation proves militarily necessary, Russia could quickly find itself in a vicious spiral of high military spending delivering a contraction in GDP, meaning that military spending rises relative to GDP and the burden becomes even higher.
Putin came to power off the back of the Russian economic collapse of the late 1990s, when its economy contracted to be smaller than Belgium’s, the Russian government defaulted on its debt and the inflation rate reached 85 percent. Putin gained a high reputation with Russians for returning the economy to growth and stability. How long the Russian people will put up with his delivering economic contraction, an inability to access Western goods, and a forever war draining the economy dry remains to be seen.
The Telegraph