Wither the Russian Economy and Sanctions

Time to start planning for a humanitarian crisis and a new Marshall Plan

Russia is a poor nation. Per capita GDP last year put the Russian Federation at roughly where the USA was in 1940. The average Russian lives on $11.400 per year, which is below the poverty level in the USA for a single person ($12,060). The difference is so stark, that it is good to see it in a graphic rather than simply in a sentence.

This poverty is sufficient that it spills over into their ability to provide public services of high quality. That is at least part of the reason their military is so shoddy. The Russian economy grew reasonably well from about 2000 through about 2014, and has since stagnated. Here’s the quarterly data. Exports account for almost 30% of production.

The Russians have an export profile that looks like that of a poor country. It is concentrated in petroleum, metals, agricultural products and other commodities. Only about 0.7% of their exports are manufactured products. This is why Senator Mitt Romney called Russia a gasoline state with nukes.

Russia actually exports more diamonds than finished manufactured goods (by dollar, not by weight).

It is a poor country, with little industrial capacity. The nation has just been hit with the broadest and most complete economic sanctions of any nation in modern times. They will find any foreign transactions difficult, are unlikely to be able to export anything of consequence, and will potentially see nearly all their exports activity ending.

The breadth of the sanctions is astonishing, and has the potential to influence every commodity, product or service. Russia risks losing parts of telecommunications services, parts for ground and air transit, food, industrial machinery and spare parts, computers and networking hardware. Nearly everything they do is at risk.

The household poverty means that the average Russian citizen will be quickly affected by sanctions. I don’t know yet what sort of food sanctions will appear, but it may not matter. A substantial share of their population will be too poor to pay for food, even it continues to flow into the country.

Just about a quarter of their population is rural. Russia is a net importer of agricultural goods, though it exports grains. The combination of poverty, large urban population share and import dependency means many Russians are at risk of being hungry in 2022.

The economic disruption of sanctions will be sufficient to generate deep income declines. The Russian government will need to print money, probably just to accommodate transactions (since many financial services companies will interrupt service). Inflation combined with deep recession will make even basic foodstuffs a challenge for many Russians.

The IIF has just forecasted a deep, 15% decline in GDP for Russia this year. That forecast is primarily driven financial and export losses. But, you can see that just sanctioning exports could double the loss to nearly 30 percent. So, I see the 15% percent forecast, which is a depression, as optimistic.

My forecast is based upon borrowing costs, economic uncertainty and export shocks. I get GDP declines it the 40% range this year from a halving of exports, borrowing costs rising to their current level and staying there for the year, along with policy uncertainty rising to its previous (early 2020) maximum.

The first two variables are self explanatory, but the policy uncertainty index provides a rough measure of overall economic activity as well. It is helpful to think through what effects occur in sanctions. The cost of borrowing is now at usurious rates, bonds are at 20% and likely to default in the coming weeks. There has been a run on banks, and Apple and Google, along with other financial service providers have ended their transactions activities. Maybe Russian banks will step in, but much of the Russian economy could be a barter economy by summer.

If oil is unsold, or experiences big export restrictions, it is hard to see how Russia finances its government without driving up inflation. No nation is likely to buy Russian bonds, so they have precipitated a long term financial crisis. No nation has experienced this level of economic disruption without significant political unrest.

The import restrictions have potentially large impacts on infrastructure and logistics. I have seen some interesting twitter feeds about the maintenance of such items as their civil air fleet. While I suspect the Russians will simply fly unsafe aircraft, there will eventually be some maintenance problems that ground air traffic, buses and rail lines. By eventually, I mean this summer.

Even if Russia quits the offensive today, this will be the biggest shock to the Russian economy since the Nazi Invasion of 1941. There are significant national security issues at play here. If I were on a DoD planning staff, I’d be preparing for a Marshall plan for both a war torn Ukraine and liberated Russia. We should be preparing immediately for a humanitarian crisis in Russia and Ukraine this summer.

Significant food production in Ukraine and Russia will also be damaged by conflict, either in the fields or destroyed in silos and storage facilities in Ukraine. Every day hostilities continue the prospects for a hungry 2022-3 get higher for both nations. The Ukrainian and Russian population push 200 million people. They cannot be fed by airlifts. There should be a separate parallel post-war planning process in place to feed the survivors of this war.