Published daily by the Lowy Institute

Russia is weaker than it looks

To really unleash economic growth, Russia would need institutional reforms that take on entrenched interests, rent-seeking and corruption.

A freight train, Russia, August 2015 (Photo: Flickr/Artem Svetlov)
A freight train, Russia, August 2015 (Photo: Flickr/Artem Svetlov)
Published 23 Jun 2017 

G7 leaders recently agreed to maintain their sanctions on Russia imposed over its belligerence in the Ukraine. The sanctions are there to punish Russian aggression and deter any further territorial expansion. But the debate over how to restrain Russia often misses a clearer understanding of the internal constraints operating on Russian President Vladimir Putin.

Russia may aspire to the great-power status its nuclear arsenal confers. But Russia is weaker than its posturing suggests, and the West has more leverage over Russia than often assumed.

In 2015 Russian military expenditure was just over $65 billion, well below the US’s $595 billion and China’s $214 billion. Russia spends almost 5.5% of its gross domestic product on defence compared to just over 3% by the US and 2% by China. India spends just over 2%, the EU 1.5%, and Japan just 1%.

This suggests a middle-income country striving to be a great power, and not always making it. In fact, Russia has suffered low growth rates since the global financial crisis, even when oil prices were high.

Russia's leadership recognises that low levels of economic growth limit the scope for action on the world stage and closer to home. Russia did not stop in eastern Ukraine because it had reached the limits of its ambitions; arguably, it stopped because it would be too expensive to continue.

Russia's current economic strategy places heavy emphasis on industry policy, with import substitution at its core. The recently released Strategy for Economic Security to 2035 does not mention import substitution explicitly, but it is replete with references to the importance of economic sovereignty.  Putin talks of the defence industry sector being the locomotive for broad economic growth. Prime Minister Medvedev sees the transport, agricultural machinery and car industries as being the basis of a new industrialisation.

The problem for Russia is that this form of economic growth is limited by distance and climate, and made worse by the location of industrial activity throughout the country, including in Siberia. Moreover, given Russia's relatively small market for such products, large-scale exports are required to achieve economies of scale. And all this effort receives extensive state subsidies in multiple forms.

To really unleash economic growth, Russia would need institutional reforms that take on entrenched interests, rent-seeking and corruption. Russia's judicial system has been plagued with corruption and inefficiency; property rights go unprotected and enforcing contracts is unpredictable. And yet there seems to be no serious effort to address these problems.

In April 2016, Putin ordered key experts to prepare the proposals on delivering sustainable economic growth. The three main contributors to the program are the Center for Strategic Developments headed by former Minister of Finance Aleksei Kudrin; the Stolypin Club, whose main spokesperson is Putin's business ombudsman Boris Titov; and the Ministry of Economic Development, headed by its new minister Dmitri Oreshkin.  

Given their previously expressed opinions, it was expected that at least the first two contributors would include institutional reform in the program. But from what is apparent from this semi-public process, serious institutional reforms are absent from the proposals. They were not mentioned by Kudrin in a recent lengthy description of his proposals; Titov has said that such things are not first priority; and Oreshkin that such matters are not part of his ministry's brief.

If old-style reindustrialisation cannot succeed and the institutional measures needed for new-style growth are not even on the agenda, reliance on Russia’s hydrocarbon sector will remain as the fall-back position. However, here Russia faces not only serious demand issues, but also questions about supply as costs and technology requirements rise in new and mature fields.

Russian history tells a persistent story of sufficient economic might to encourage great-power behaviour, but also of persistent restraints on economic growth that make such behaviour sustainable only at the cost of the system's viability. Putin's behaviour reflects a realisation that when resources are tight they must be conserved so that the system doesn't become unbalanced.

The West must be realistic about what it can and wants to do to influence Russian behaviour by economic means. To drive the Russian economy into the ground is neither within the West's capacity nor desirable. To increase the cost of unacceptable behaviour through clearly linked economic measures is effective and desirable. Sanctions serve the purpose.

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