LocationsFor almost three years now, Putin's Russia has been waging an unprovoked war of aggression against Ukraine. The toll in terms of lives lost and human misery on both sides is horrific. Yet, the Russian economy appears to be thriving, leaving Germany trailing in the dust in terms of growth (see Figure 1). Russia's unemployment rate stands at a meager 2.6% – full employment! How is this possible?
Fig. 1: GDP growth Russia versus Germany
A war economy in full swing
The answer lies in a red-hot war economy. Production in warcritical industries has doubled since the war began, while the rest of the manufacturing sector stagnates. There are also significant one-off investments in infrastructure to redirect oil and gas from Europe to Asia. High commodity prices and booming trade with China and India allow for financing without significant budget deficits.
The hard times are yet to come
However, the Russian boom is built on shaky ground. Even before the war – or as Putin wants us to call it, the "special military operation" – Russia's long run growth prospects were bleak and have since deteriorated further. The transformation to a statecontrolled war economy brings with it increasingly economic practices inspired by Soviet-era central planning. This lowers the maximum potential productivity growth. It also makes a shift from a resource-based to a more diversified economy even more unlikely. Even the once well-funded national wealth fund, which had been fed by oil and gas revenues, has been depleted by Putin to finance the war. How can the Russian economy ever become more diversified?
One is reminded of former U.S. presidential candidate John McCain's 2014 remark (back when the Republican Party still existed...): "Russia is a gas station masquerading as a country."
Demographic challenges intensify
However, the biggest issue facing the Russian post-war economy is likely to be demographic. Even before the war, the United Nations projected an annual population decline of over half a million people. Now, an estimated 600,000 soldiers have fallen at the front – so far. Plus, there are the young, mostly male and well-educated Russians who are fleeing the country to avoid conscription and oppression. Since the war's onset, almost a million people have left Russia. One hundred thousand IT profes?sionals are believed to have emigrated. With whom does Putin plan to develop the country in the future?
Making sanctions watertight
Russia's economy has proven more resilient than many, including myself, expected, and this is partly due to porous sanctions. Kyrgyzstan has particularly distinguished itself as a hub for sanction evaders. German exports to the Central Asian country have increased more than tenfold compared to pre-war levels. It is reasonable to assume that most of these goods are being smuggled into Russia. In fact, the imports from Germany recorded by Kyrgyz customs are much less than Germany's exports to the country. The intermediaries in Bishkek don't even bother pretending that the goods are staying in Kyrgyzstan.
It is high time the EU plugs these gaps and adds Kyrgyzstan to the sanctions list. This won't destroy Russia's economy, but it could destabilize the regime if the supply of German cars and French handbags deteriorates.
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