Sanctions are undermining Putin’s economy

Harley Balzer,
Professor Emeritus,
Georgetown University,
USA

Debates about the effectiveness of sanctions in response to Russian annexation of Crimea and aggression in Eastern Ukraine have persisted. Russian officials and many analysts proclaim the sanctions a failure. Substantial evidence demonstrates that sanctions are having an impact in ways both expected and unintended.

The quality of Russia’s economy is being undermined. It is increasingly less diverse, more dependent on commodities, more state owned and controlled, more concentrated in a few productive regions and enterprises, and more predatory. Flawed policies in response to Covid are exacerbating an already alarming demographic situation.

During the boom years of rising oil prices in 2000-2008, Putin’s regime returned to Soviet-era reliance on importing advanced technology. The vast majority of equipment for oil and gas production, electronics and machine building is imported. Successful import substitution in industry remains scarce. Russian oil and gas producers increasingly depend on equipment that is beyond its expected life span.

Oil and gas firms will find their technology capacity increasingly challenged in the 2020s. Older production sites are tapped out, while new ones are more remote and challenging to exploit. Offshore and arctic drilling requires technology subject to sanctions.

If pledges by leading industrial nations to substantially reduce reliance on hydrocarbons by 2030-35 are realized, the impact on countries relying on oil, gas and coal exports could be massive.

The global shortage of chips has exacerbated an already desperate situation in electronics and machine building. Russia continues to produce and export basic equipment while importing more costly advanced machinery. By 2019 Russian policy shifted from developing domestic capacity in these industries to seeking to purchase foreign factories and localize assembly plants, proclaiming them domestic producers.

Sanctions make this approach increasingly difficult and expensive. It is a dubious long-term solution, potentially subject to additional sanctions.

Most of the “super weapons” President Putin showcased in March 2018 have been delayed. Lack of crucial imported components is amplifying the typical bottlenecks in developing sophisticated military technology.

Despite much talk and regular joint military exercises, China is doing little to help Russia offset technology sanctions or modernize its defense industry. China cannot replace the most important sanctioned equipment and components because it does not possess the crucial advanced technologies Russia lacks. China, too, is suffering from the global shortage of computer chips.

While reasonably good macro economic policy has kept Russia’s federal debt low, Russian regions, enterprises and consumers are increasingly burdened with the need to repay substantial loans. Another tremor in the global economy could produce widespread defaults.

Russia lacks outside sources of investment. Enthusiasm for cooperation with China in 2014 was quickly stifled as Chinese enterprises and banks contemplated secondary sanctions.

China has refused to help finance the export pipelines Russia needs to move oil and gas to Asia, and has used the Coronavirus recession to push for lower prices on oil and gas.

China has failed to provide the anticipated support for developing Russia’s Far East. Only two of 20 joint projects identified in 2009 were realized. Chinese firms operating in Russia bring their own managerial and technical personnel, hiring locals for menial labor.

Agriculture appeared to be a Russian success, but has been seriously affected by Putin’s counter sanctions. Russia is again a major grain exporter, with agriculture now second to hydrocarbons in Russian export earnings, ahead of arms sales.

Substituting chicken and pork for beef kept Russian meat production at pre- sanctions levels. Russian producers have replaced some food imports, frequently at higher prices and sometimes lower in quality. Years of declining incomes have left a substantial share of the Russian population finding it increasingly difficult to manage household budgets

Despite Putin’s claims of having punished Europeans, Russian counter sanctions have not imposed significant costs on former exporters. Global markets have adjusted.

Without changes in Russian policy, the impact in the coming decade will make long- term decline in the quality of Russia’s economy increasingly difficult to reverse.

Sanctions could be made more effective by improving cooperation and enforcement among allies, expanding technology sanctions, publicizing damage resulting from Putin’s counter sanctions, and targeting Novatek’s LNG operations, controlled by Gennady Timchenko, one of Putin’s shadow bankers. More extreme options include sanctions against Russia’s secondary debt market, and excluding Russia from the SWIFT international payments system.

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