Russia’s Defensive Economic Model: Paper Tiger Reforms and State-led Investment Spending as Patchwork Fixes

In terms of economic policy, Russia has experienced several U-turns in recent years. In the 2000s, stability orientation dominated in light of the 1990s crisis. The cornerstones were a cautious monetary and fiscal policy.

To a large extent, the so-called “Washington Consensus” was followed, i.e., a stability-oriented economic policy as the Western-dominated International Monetary Fund would have probably recommended, including establishing a politically highly independent central bank. Academia, the population, and state leadership supported this orientation.

Focus on stabilization and “reform tuning”

After the macroeconomic stabilization success, economic policy has been shaped by two further impulses: On the one hand, Russia pursued so-called “reform tuning.” On the other hand, efforts were made to promote internationalization.

“Paper tiger” reforms made it possible to advance in international benchmarking, most prominently in the World Bank Doing Business Index. Russia was ranked 120^th in 2011 and 111^th in 2012 in the annual Ease of Doing Business rankings.

Then in 2015, ranked 36^th and 28^th in 2020, a trend development reflecting “reform tuning,” i.e., policymaking focused on changing exactly those laws and regulations of importance for such measurements and without focusing on real change. Such “fictional successes” also served as a means to attract foreign direct investment (FDI).

At the same time, Russian companies made international acquisitions, and direct investments from Russia increased. There was even the ambition to establish Moscow as a global financial center on the back of macroeconomic stabilization successes and financial market liberalization determinations.

Russian In- & Outward FDI vs. Global Trends
Source: UNCTAD, World Investment Reports

The end of the “social contract”: Prosperity no longer compensates for fewer individual freedoms

In the background, the state maintains a considerable influence on the economy, especially in strategic sectors. Apart from stabilization and “reform-tuning,” there has been no profound microeconomic and institutional transformation since the mid- 2000s.

At the beginning of the 2010s, the state-centered economic model reached its limits in terms of growth and innovation. Since 2013/14, the state has bought legitimacy through geopolitical “successes” based on increasing military spending. In terms of economic policy, the focus has been on securing living standards and geopolitical leeway.

A “Fortress Russia” strategy

Since 2013/14, Russia has pursued a new strategy in the context of Western economic and financial market sanctions- knowing that sanctions could be tightened at any time. It now follows an ultra-stability-oriented fiscal and monetary policy meant to secure geopolitical leeway.

Russia presents as a defensive, inward-looking economic model in the real economy (e.g., import substitution) and in international financing (e.g., limited use of the US dollar).

In some areas, the strategic goal is autarky, an economic policy objective that often characterizes dictatorships. Tactically, the main aim is to be prepared for any economic shock, including oil price shocks or possible tightening of sanctions.

Rising social inequality and falling real incomes have challenged the defensive economic model since 2018/19

At first, successes were recorded. Russia was able to stand its ground in a challenging (sanction) environment, and, according to the political narrative, external sanctions were to blame for weak growth.

Those in power were able to engage in so-called “stagnation marketing” for a limited period. However, criticism in the domestic discourse increased, and calls have been heard – partly populist – for a growth-oriented economic policy, such as an activist monetary and/or fiscal policy – especially as it is becoming apparent that the sanctions could remain in place for many years to come.

Launch of the “National Projects” in 2018

The multi-layered pressure to mobilize national resources and find a new “growth and modernization narrative” led to the “National Projects” launch in 2018. Substantial sums were announced for large-scale state investment and modernization programs through 2024.

Since modernization goals have been linked to staying in power from the beginning, the target date of 2024, the next presidential election, speaks volumes.

Investment and reform priorities were announced in demography, health, education, living conditions, ecology, roads, labor productivity, science, digital economy, culture, small business, and international cooperation. The military-industrial complex was not directly included, a concession as it received high investment in the past.

From 2018 to 2024, approximately 250-350 billion euros were made available for national investment programs. On the surface, the willingness to invest has increased. In 2012, 35-45 billion euros were allocated for the period 2012-2018 with a similar target. On a year-to-year basis, investment should increase from 0.2-0.4 percent of GDP (2012-2018) to about 3 percent (2018-2024).

Arithmetically, this implies an investment of 4-6 percent of GDP. In light of practical experience in Russia’s “oligarch economy,” which is also deeply embedded in the political system, it can be expected that only 40-50 percent of the funds will arrive in the real economy.

In view of experience with state infrastructure and investment initiatives, this could generate growth effects of 0.4-0.8 percent, which would allow for maximum potential GDP growth of just over 2 percent.

Buzzwords without deeper implementation and reform planning

In the beginning, there were signs of euphoria – including among domestic market observers – in light of this new economic policy orientation, especially since excessive (foreign exchange) reserve accumulation is inefficient. The accompanying (safe) financial investments bring neither financial gains nor real economic impulses.

However, in terms of their implementation, the successes of the National Projects were modest in 2019 and up until the Corona crisis. Although the cornerstones of the National Projects well reflect Russia’s domestic challenges, observers view the government’s implementation plans to be contradictory because they call for both more freedom and more planning of the economy.

The Corona crisis was used opportunistically to prioritize economic policy, stretch out the National Projects’ timetable, and make modernization less ambitious. The target date of 2024 became 2030, and in addition to the focus on macroeconomic impulses, some microeconomic liberalizations were also introduced.

Moreover, investments are to be financed to a greater degree through reserves, such as the National Wealth Fund. For the first time, a clear ramping up of government spending in a crisis was discernible; a pure austerity and stabilization policy was apparently no longer enforceable.

At the same time, however, the government is trying to avoid a complete escalation of sanctions, which would imply an even more adverse economic scenario.

Self-inflicted stagnation

All in all, the economic policy of recent years makes a hectic and eclectic impression. There is an obsessive attempt to produce state-induced growth and modernization, which evaporate given the rigidities of institutional conditions; comprehensive internationalization is no longer a goal. Structural reforms in sensitive areas, such as an overhaul of the judicial system or a comprehensive fight against corruption, are not discernible.

Long-term Economic Growth Perspectives
Source: Rosstat, International Monetary Fund (Developed Markets and Emerging Markets), Forecasts Russian GDP growth 2021-2025

Outlook

In 2021 and perhaps also in 2022, Russia can achieve near-term GDP growth rates of 3 percent in light of the global post-COVID-19 recovery. Such growth rates are considerably higher than in recent years, where GDP growth averaged 1.7 percent. However, even this represents a relative decline given the 4-6 percent GDP growth rates in developed economies such as Germany or the US.

The growth prospects for Russia’s economy are limited, despite certain economic policy growth initiatives. Therefore, it is very unlikely that the political system will be able to (re)achieve some legitimacy through economic progress in the foreseeable future.

Given the limited possibility of achieving GDP growth rates of more than 1.5-2.0 percent on a sustained basis (following a one-off rebound recovery in 2021/2022), the economic and political risk of prolonged stagnation and further sanctions increases.