ECONOMY
The End of ‘Military Keynesianism’ in Russia
December 9, 2024
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Tatiana Rybakova
Journalist and writer
Journalist Tatiana Rybakova argues that private business in Russia is increasingly under pressure, which threatens to undermine the market mechanisms essential to the stability of the entire Russian economy.
About six months after Russia’s invasion of Ukraine in 2022, the term “military Keynesianism” became fashionable among Russian economists. Having witnessed the Russian economy cope with the first wave of sanctions, many began to argue that in the market economy, the war had become an opportunity, not a threat, for many businesses.
This was especially true for heavy industry: it had always had a defense component, but whereas previously the need to maintain this capacity weighed it down, with the onset of the war, defense production brought profits. Indeed, industrial growth began to gain momentum as early as the latter half of 2022. However, in recent months there have been signs that this growth – especially in heavy industry – is running out of steam.
This was especially true for heavy industry: it had always had a defense component, but whereas previously the need to maintain this capacity weighed it down, with the onset of the war, defense production brought profits. Indeed, industrial growth began to gain momentum as early as the latter half of 2022. However, in recent months there have been signs that this growth – especially in heavy industry – is running out of steam.
The Sukhoi Superjet 100, designed by the Russian aircraft company Sukhoi Civil Aircraft, has been involved in numerous incidents, likely due to limited access to imported parts. On one day in November alone, there were five incidents. Source: Wiki Commons
Steel and airplanes
For example, steel output has been falling this year across almost all producers – and steel is the most needed metal for the war. For the first 10 months of 2024, production in Russia was down 7% versus the previous-year period. And though manufacturing activity, as measured by the sector purchasing managers’ index (PMI), is rising, it does not indicate much optimism, at 51.3 points in November versus 50.6 in October. As noted in the S&P Global press release, “input costs and output charges rose at steeper rates, as inflationary pressures mounted.”
Even more surprising is the decline in freight volumes. Freight transported by rail, the main mover of heavy industry production, has tanked, falling 5.2% year over year in the first 11 months of 2024. The overall picture is a strange one: industry is producing more and more, but it is all disappearing at the factory gate.
Perhaps this is not such a mystery, however. Recall that executives at the largest Russian aircraft makers were recently fired. The reason: the obvious failure of the project to build the Yakovlev MC-21 passenger jet – the now-former top managers had promised six months ago to deliver the planes to airlines as early as 2025 (see Russia.Post here).
The situation in the Russian aviation sector is close to catastrophic. The extremely disappointing Sukhoi Superjet 100, suffering from a lack of imported parts, has recorded incident after incident – only by a miracle has there not been a disaster. For example, a Superjet caught fire in Turkey at the end of November. Overall, the number of aviation incidents in Russia this year is the highest in the past six years at more than 200. Meanwhile, almost half of Western-made aircraft are grounded for lack of parts.
Steel and machine tools are not airplanes, and the problems in industry are not as visible to the public. (Though the fact that Russian bombs and missiles regularly fall on Russian border towns says a lot about the quality of the products manufactured.) Not everything is well in the extractive sector either. Especially with coal, which had just recently been doing well: things have got so bad that the government has axed export duties on coal early, effective December 1.
For example, steel output has been falling this year across almost all producers – and steel is the most needed metal for the war. For the first 10 months of 2024, production in Russia was down 7% versus the previous-year period. And though manufacturing activity, as measured by the sector purchasing managers’ index (PMI), is rising, it does not indicate much optimism, at 51.3 points in November versus 50.6 in October. As noted in the S&P Global press release, “input costs and output charges rose at steeper rates, as inflationary pressures mounted.”
Even more surprising is the decline in freight volumes. Freight transported by rail, the main mover of heavy industry production, has tanked, falling 5.2% year over year in the first 11 months of 2024. The overall picture is a strange one: industry is producing more and more, but it is all disappearing at the factory gate.
Perhaps this is not such a mystery, however. Recall that executives at the largest Russian aircraft makers were recently fired. The reason: the obvious failure of the project to build the Yakovlev MC-21 passenger jet – the now-former top managers had promised six months ago to deliver the planes to airlines as early as 2025 (see Russia.Post here).
The situation in the Russian aviation sector is close to catastrophic. The extremely disappointing Sukhoi Superjet 100, suffering from a lack of imported parts, has recorded incident after incident – only by a miracle has there not been a disaster. For example, a Superjet caught fire in Turkey at the end of November. Overall, the number of aviation incidents in Russia this year is the highest in the past six years at more than 200. Meanwhile, almost half of Western-made aircraft are grounded for lack of parts.
Steel and machine tools are not airplanes, and the problems in industry are not as visible to the public. (Though the fact that Russian bombs and missiles regularly fall on Russian border towns says a lot about the quality of the products manufactured.) Not everything is well in the extractive sector either. Especially with coal, which had just recently been doing well: things have got so bad that the government has axed export duties on coal early, effective December 1.
“A pattern has emerged in commodity sectors: the government decides to shake a company down to pad state coffers, and its profitability plummets.”
The Uralvagonzavod plant, where military equipment is developed and produced. Nizhny Tagil, Sverdlovsk Region. Source: Wiki Commons
This has happened to Gazprom and now Transneft, which had its profit tax hiked to 40%. The affected companies are compensating for this by raising prices, which, even after the government reduces its demands, are not lowered back to their previous levels. The authorities still take care of exporters where they can: for example, despite the big slide in the ruble exchange rate, they do not plan to make companies with earnings abroad sell more foreign currency than they already do.
Beating a dead horse
The reason for the failure of “military Keynesianism” in Russia, according to economist Nikolai Kulbaka, is that it works well only when there is a lot of spare capacity and labor.
“A classic example is the US during World War II, when they were able to put to work capacity and workers that had been freed up by the Great Depression,” says Kulbaka. But in Russia, even before 2022, industry did not have any major spare capacity, while unemployment was low and had been on a steady decline for a decade. Over the last few years, amid the acute labor shortage, unemployment has been practically nonexistent, amounting to 2.3%.
Kulbaka identifies three phases of business sentiment since the beginning of the war. In the first half of 2022, businesses felt that the war would not last long, so they hurried to profit from it and occupy new niches. At the same time, there were resources in the form of capacity left by exiting foreign companies, along with demand for import-substituted products amid sanctions and the hard ban on Western firms’ selling sensitive technology.
However, “already after mobilization in autumn 2022, it became clear that the war was dragging on,” Kulbaka notes. It was then that the second phase began: looking at the budget for 2024-26, many businesses decided that everything would be wrapped up in 2024: after all, huge fiscal expenditures for defense and security were budgeted only through 2024.
“The big fiscal injections into the economy flooded it with money: wages began to rise, inflation rose, costs rose, but profits rose too,” says Kulbaka. It seemed that Russia had weathered the storm: there was money, the “global South” was with us and would help Russia to resist the West, we had coped with sanctions, and logistics chains, rerouted from West to East, got up and running.
It was precisely these sentiments of late 2023-early 2024, Kulbaka believes, that led to the confidence among many economists that “military Keynesianism” was working. “These sentiments began to fade already in the second half of 2024,” he thinks.
That was when the Central Bank began to take desperate measures to combat inflation, aggressively hiking its key interest rate. Meanwhile, not only did the BRICS+ countries fail to offer Russia anything concrete, but they also started obediently complying with the Western sanctions, keen not to be sanctioned themselves. “It became clear that they were sitting on two chairs, and they were sitting on the Western chair much more,” Kulbaka notes.
Beating a dead horse
The reason for the failure of “military Keynesianism” in Russia, according to economist Nikolai Kulbaka, is that it works well only when there is a lot of spare capacity and labor.
“A classic example is the US during World War II, when they were able to put to work capacity and workers that had been freed up by the Great Depression,” says Kulbaka. But in Russia, even before 2022, industry did not have any major spare capacity, while unemployment was low and had been on a steady decline for a decade. Over the last few years, amid the acute labor shortage, unemployment has been practically nonexistent, amounting to 2.3%.
Kulbaka identifies three phases of business sentiment since the beginning of the war. In the first half of 2022, businesses felt that the war would not last long, so they hurried to profit from it and occupy new niches. At the same time, there were resources in the form of capacity left by exiting foreign companies, along with demand for import-substituted products amid sanctions and the hard ban on Western firms’ selling sensitive technology.
However, “already after mobilization in autumn 2022, it became clear that the war was dragging on,” Kulbaka notes. It was then that the second phase began: looking at the budget for 2024-26, many businesses decided that everything would be wrapped up in 2024: after all, huge fiscal expenditures for defense and security were budgeted only through 2024.
“The big fiscal injections into the economy flooded it with money: wages began to rise, inflation rose, costs rose, but profits rose too,” says Kulbaka. It seemed that Russia had weathered the storm: there was money, the “global South” was with us and would help Russia to resist the West, we had coped with sanctions, and logistics chains, rerouted from West to East, got up and running.
It was precisely these sentiments of late 2023-early 2024, Kulbaka believes, that led to the confidence among many economists that “military Keynesianism” was working. “These sentiments began to fade already in the second half of 2024,” he thinks.
That was when the Central Bank began to take desperate measures to combat inflation, aggressively hiking its key interest rate. Meanwhile, not only did the BRICS+ countries fail to offer Russia anything concrete, but they also started obediently complying with the Western sanctions, keen not to be sanctioned themselves. “It became clear that they were sitting on two chairs, and they were sitting on the Western chair much more,” Kulbaka notes.
“Business realized that investments from the East were not forthcoming, nor was technology. Some parts could still be brought in by roundabout routes, but not everything.”
On top of that, financial sanctions made payments harder, and the easy money in the economy started to dry up. Meanwhile, the labor shortage began to take a toll – this is perhaps the biggest issue for business today. Though “there is a catastrophic shortage of people,” in Kulbaka’s view, it is not because the defense sector is sucking up workers: “I do not see any special migration of labor resources into the military-industrial complex: the number of workers there has increased, but not massively. I assume that they are rather forcing existing workers to work more time.”
The shortage of workers has pushed up wages, meaning higher costs and lower profits. At the same time, the problems with payments and supplies mean that even where previous supply and sales channels have remained operational, everything moves slower. So, Kulbaka says, “firms have to borrow, sometimes on prevailing market terms, and their debt burden is growing.” Keep in mind that many businesses were heavily indebted even before the war, as pandemic-era restrictions were coming to an end and there was hope for a rapid rebound, he adds.
Finally, shipping problems have weighed heavily on businesses. Kulbaka blames the state monopoly Russian Railways, which in previous years invested little in infrastructure. “And on top of this, there is a shortage of people, a shortage of locomotives due to sanctions: 800 locomotives need to be replaced every year, but only 500 are bought, and there are also issues with repairs due to a shortage of foreign spare parts,” he notes. Trucks will not save the day – the density of motorways in Russia is extremely low. Overall, there is no way to change the situation quickly.
The labor shortage in the economy is being compounded by an ongoing crackdown on migration, even though migrants are the key component of the workforce in some industries, like construction. “It is impossible to replace them with Russian citizens, because there are not enough of them. They are already hiring pensioners, but they will not be there for long,” says Kulbaka.
Along with law enforcement raids targeting migrants (where those who have come to Russia illegally are kicked out of the country, while those who are there legally are issued draft papers), the Duma is considering a raft of bills that would toughen the punishment – in particular, introducing criminal liability – for illegal migration and abetting that.
The economic outlook is grim, Kulbaka notes: every year, the working population will drop 300,000-400,000 for demographic reasons; the war takes another 20,000-30,000 hands per month off the labor market. “Defense industry firms suffer from the labor shortage no less than others, because young people are reluctant to go there: they are put off by the long hours and impossibility of going abroad due to state secrecy,” he adds.
So, Kulbaka believes, industry is not growing after all: “sure, the volume of output is growing, but at a higher cost.” In addition, the quality of the production leaves something to be desired. “For example, when a foreign investor exited a railroad bearings maker and Russian owners took over, the defect rate on the same machines increased to 80% in the first months, and today it has only been reduced to 30%,” he explains.
Thus, rosy official statements are beginning to conflict with the alarm bells going off at firms. The Russian economy has reached an important juncture: all the previous drivers of growth have been exhausted, and negative factors are only just beginning to have an effect.
“I do not expect any major implosions at this point,” says Kulbaka. “But we must understand that the limitations are already visible.” “Military Keynesianism” in Russia is on its last legs.
The shortage of workers has pushed up wages, meaning higher costs and lower profits. At the same time, the problems with payments and supplies mean that even where previous supply and sales channels have remained operational, everything moves slower. So, Kulbaka says, “firms have to borrow, sometimes on prevailing market terms, and their debt burden is growing.” Keep in mind that many businesses were heavily indebted even before the war, as pandemic-era restrictions were coming to an end and there was hope for a rapid rebound, he adds.
Finally, shipping problems have weighed heavily on businesses. Kulbaka blames the state monopoly Russian Railways, which in previous years invested little in infrastructure. “And on top of this, there is a shortage of people, a shortage of locomotives due to sanctions: 800 locomotives need to be replaced every year, but only 500 are bought, and there are also issues with repairs due to a shortage of foreign spare parts,” he notes. Trucks will not save the day – the density of motorways in Russia is extremely low. Overall, there is no way to change the situation quickly.
The labor shortage in the economy is being compounded by an ongoing crackdown on migration, even though migrants are the key component of the workforce in some industries, like construction. “It is impossible to replace them with Russian citizens, because there are not enough of them. They are already hiring pensioners, but they will not be there for long,” says Kulbaka.
Along with law enforcement raids targeting migrants (where those who have come to Russia illegally are kicked out of the country, while those who are there legally are issued draft papers), the Duma is considering a raft of bills that would toughen the punishment – in particular, introducing criminal liability – for illegal migration and abetting that.
The economic outlook is grim, Kulbaka notes: every year, the working population will drop 300,000-400,000 for demographic reasons; the war takes another 20,000-30,000 hands per month off the labor market. “Defense industry firms suffer from the labor shortage no less than others, because young people are reluctant to go there: they are put off by the long hours and impossibility of going abroad due to state secrecy,” he adds.
So, Kulbaka believes, industry is not growing after all: “sure, the volume of output is growing, but at a higher cost.” In addition, the quality of the production leaves something to be desired. “For example, when a foreign investor exited a railroad bearings maker and Russian owners took over, the defect rate on the same machines increased to 80% in the first months, and today it has only been reduced to 30%,” he explains.
Thus, rosy official statements are beginning to conflict with the alarm bells going off at firms. The Russian economy has reached an important juncture: all the previous drivers of growth have been exhausted, and negative factors are only just beginning to have an effect.
“I do not expect any major implosions at this point,” says Kulbaka. “But we must understand that the limitations are already visible.” “Military Keynesianism” in Russia is on its last legs.
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