Russia’s War Economy Wilts Under Sanctions as Measures Become More Targeted

Executive Summary:

• Western sanctions, heavy losses in Ukraine, and short-sighted Kremlin policies have put serious strain on the Russian economy, even if Moscow has managed to weather the storm in some sectors. 
• The Russian economy is grappling with significant structural issues, including dwindling economic reserves, labor shortages exacerbated by demographics, heavy war casualties, and mass emigration. High inflation and rampant corruption are also contributing to economic instability in Russia.
• Russia’s severe labor shortages, especially in sectors critical for the military, offer a strategic lever for Ukraine and the West. Heavy losses at the front could cause Moscow to consider mass mobilization, which will place further stress on the Russian labor market and probably would trigger another wave of emigration. 
• More can be done to target Russia’s oil sector, as it remains the Kremlin’s main cash cow for funding the war. One option is to reconsider implementing a more stringent price cap, which Poland earlier proposed at $30 per barrel.
• Shining a light on widespread disdain for Moscow’s policies and interethnic tensions within Russia—particularly involving migrant workers and non-Russian ethnic groups—could be exploited to put more pressure on the Kremlin. 
• The Kremlin’s focus on channeling more spending to the military-industrial complex has created an illusion of rapid economic growth. In reality, this spending has exacerbated economic problems that could lead Russia toward wider economic failures.
• Facilitating Ukraine’s pressure on Russian forces at the front and in Kursk as well as implementing expanded and more targeted sanctions are crucial to intensifying economic pressure in decimating Moscow’s ability to wage war.

Otto von Bismarck’s remark that Russia is never as strong or as weak as she looks seems to accurately illustrate the overall effects of Western sanctions on the Russian economy since Moscow expanded its invasion of Ukraine. While sanctions have certainly damaged and curtailed some economic sectors, the Kremlin has been able to weather the storm in other regards. Propaganda narratives, boastfully promoted by Russian President Vladimir Putin, claim that “sanctions do not work” and may even strengthen the economy (Vedomosti, May 24). Such messaging has been vigorously supported not only by pro-Russian actors in the West with financial links to the Kremlin but also reputable international financial and economic institutions, think tanks, and individual experts who take Moscow’s claims at face value. For instance, with assessments based on Russian-generated data, the International Monetary Fund (IMF) has praised Russia’s economic growth, which the IMF claims has demonstrated higher rates of growth than the majority of the world’s most developed countries (Imf.org, April 2024). 

The reality, however, is quite different. The Russian economy, while appearing red hot on the surface, is seriously sick, with growth being fueled by increasing and unsustainable war expenses (see EDM, January 12, October 2, 2023, February 12, June 26). Economic reserves are rapidly dwindling, while labor shortages are becoming increasingly acute due to challenging demographics, heavy losses in Ukraine, and massive emigration (see EDM, August 18, 2022, September 8, October 23, 2023, January 16, June 27, July 16, 24). Meanwhile, Russia’s regions, especially those that are not majority ethnic Russian, are becoming increasingly unstable, and the prospect of interethnic conflict does not seem unrealistic as non-Russians are being disproportionately sent to the “meat grinder” in Ukraine (see EDM, November 2, 2023, July 30, August 15). Finally, despite the bravado of Kremlin propaganda, the views of Russia’s ruling elite on the war and economic woes are not as monolithic as they appear on the surface. Nevertheless, more can be done to tighten sanctions measures and introduce more targeted measures to wholly cripple the Russian economy and Moscow’s ability to maintain the war effort (see EDM, April 3). 

How Russia’s Economy Has Weathered the Storm 

Prominent Russian/Soviet military theorist Alexander Svechin differentiated between two types of warfare: rapid destruction (sokrusheniye) and slow attrition (izmor) (Nvo.ng.ru, September 15, 2017). Having failed to gain victory early in the war (sokrusheniye), Russia began to gradually switch to a “long war of attrition” (izmor) that has warranted, among other measures, a major restructuring of the economy to serve war needs (see EDM, July 12, October 31, 2022, October 2, 2023, February 26, April 1, May 20, July 10). 

After failures on the Ukrainian battlefield in the spring and fall of 2022, it became clear that Russia’s economy had begun to be mobilized to a war footing and adjusted accordingly. At that time, calls for the need to mobilize the economy came from three notable figures: Vladimir Mau, rector of the Russian Presidential Academy of National Economy and Public Administration (Ko.ru, October 20, 2022); Vladimir Litvinenko, rector of Saint Petersburg Mining University and Putin’s political campaign manager in 2000 and 2004 (RG.ru, June 9, 2022); and Nikolai Patrushev, the then-secretary of the Russian Security Council (The Moscow Times, November 16, 2023). These officials argued for the need to “do away with offsprings of capitalism.” To the astonishment of many Russian businesses, they also urged an end to the system of “parallel imports” to stimulate domestic production in a move toward autarky, as foreign goods, primarily Western, were saturating Russia’s consumer market (The Moscow Times, October 31, 2023). Yet, instead of all-out nationalization and the return to a Soviet-style planned economy, Russia’s political leadership opted for a different path: continuing “gray” parallel import schemes, introducing “manual” management of the economy, and pumping more money into war-related industries (BBC Russian Service, January 11). 

Overall, the Russian economy has not survived only because of macroeconomic decisions taken by the Central Bank and other institutions. Russia’s ability to withstand sanctions rests on two main factors. First, the nature of the Russian economy—a “gas station masquerading as a country” whose share in the global production of innovative products and cutting-edge technologies is insignificant—has rendered some economic sanctions, especially earlier measures, minimally effective. Moscow has continued to export its raw materials, commodities, and energy resources, cashing in on revenue critical for financing the war (Macdonald-Laurier Institute, March 22; see EDM, February 6, 2023, May 21). Despite the price cap instituted by the Group of Seven (G7) and EU countries, which agreed that Russian oil could not be sold above $60 per barrel, “oil money” has continued to flow into the Russian economy (Kommersant, September 28, 2023). 

The second factor that has assisted Russia in the face of sanctions was the half-hearted and inadequate sanctions introduced in 2014 in the wake of Moscow’s illegal annexation of Crimea and invasion of Donbas. In practice, these sanctions gave the Russian economy plenty of “breathing room” and enabled Moscow to begin preparing for potentially stronger sanctions in the future (Carnegie Politika, March 20; Kuzio, Crimea: Where Russia’s War Started and Where Ukraine Will Win, July 8).

In the meantime, the Kremlin increased the channeling of money into select sectors of the economy, with a special focus on industries within the country’s military-industrial complex (see EDM, January 16, May 30). Payments were also increased for recruits and contract soldiers, with total defense and security expenses reaching nine percent of Russia’s gross domestic product (GDP) and an astounding 30 percent of the central budget, which largely explained the growth in GDP (Istories.media, June 1, 2023; RBC-Ukraine, July 24). This “economic growth” touted by the Kremlin was, by and large, an illusion and yet another example of Moscow’s penchant for “military Keynesianism”—that is, increasing military expenditures to spur rapid GDP growth. 

Challenges in Russia’s War Economy 

Today, due to the Kremlin’s short-sighted policies and the tightening of Western sanctions, the Russian economy is plagued by a number of serious structural problems. First, Russia is already experiencing a dire shortage of personnel for its workforce (see EDM, September 8, 2023, January 16, June 27). In addition to an intensifying demographic crisis, hundreds of thousands, if not millions, of young educated people and qualified professionals fled Russia following Putin’s announcement of a “partial mobilization” in September 2022 (see EDM, August 18, September 22, June 30, October 11, 2022, October 24, 2023, February 6; Novaya Gazeta, July 19). On top of that, the Russian military has suffered hundreds of thousands of casualties in Ukraine, which has further exacerbated labor shortages in the domestic economy (see EDM, December 21, 2023, July 16, 24). The dwindling workforce has been one of the key factors in growing wages and salaries for Russian workers (by more than 30 percent in some industries) as competition for labor escalates between defense-related and civilian sectors. This competition has led to an unsustainable growth in salaries and wages and poses the risk of paralyzing those sectors of the economy that will be unable to offer competitive financial remuneration. 

Second, Russia has already spent much of its economic reserves on propping up its economy and covering war needs with little recourse for short-term replenishment. Russian Central Bank Governor Elvira Nabiullina articulated these realities during a press conference in July (The Moscow Times, July 26). While Moscow continues receiving revenues for its raw materials and commodities, the effect of more targeted sanctions coupled with growing war expenses will likely apply an added measure of pressure on the Russian budget (see EDM, January 12, 2023, February 12). Some notable Russian economists have tried to argue that the lack of reserves will not have a major impact on the Russian economy, as it is now more isolated from the global economy (Istories.media, May 14). Yet, while this factor alone may not bring down the Russian economy, it could certainly cause further degradation as the war continues and Russia’s global isolation deepens.

Third, inflation continues to grow despite efforts to curtail it. In July, the Russian Central Bank openly admitted that inflation had reached 9.2 percent, which is two-times higher than the target set earlier in 2023 (RG.ru, July 26). After admitting to a serious overheating of the Russian economy, Nabiullina announced an increase of the interest rate to 18 percent—in 2020, the rate was a mere 4.2 percent—with a prospect of reaching 19 percent (RBC, April 22, July 26; Russian Central Bank, July 26). In effect, some economists have argued that the fear of uncontrollable inflation, akin to what Russia experienced in the early 1990s, is one of the factors that precludes the Kremlin from launching a second wave of mobilization, instead prompting Moscow to rely on so-called “volunteer formations” (see EDM, April 4, 9, 16, 30; Novaya Gazeta, July 19). 

Fourth, corruption is rampant in all spheres of Russian society, including in the Ministry of Defense and among the siloviki (Lenta, May 4). Such corruption has led to a thorough degradation of the Russian military in Ukraine and has further exacerbated Russian society’s economic woes (see EDM, July 29).  

Despite these challenges, in general, Russia is still capable of waging a low-intensity war with a tolerable rate of casualties (under 1,000 men per day) for years (24tv.ua, May 31). In many ways, the indecisiveness of Ukraine’s Western partners, “drip, drip” in the supply of arms and munitions, and restrictions on Ukrainian forces using the provided long-range capabilities to strike Russian territory have enabled this reality. Even so, Moscow will struggle to maintain its current level of fighting. Additionally, with economic sanctions being extended to Russian uranium and diamonds, China openly exploiting Russia’s resources, and monthly losses at the front exceeding the number of recruits joining the military, the Kremlin’s ability to effectively keep up with its war needs while resolving domestic issues has been seriously damaged (see EDM, June 3, July 23; The Moscow Times, July 29 [1], [2]; Freedom Information Portal, July 31). 

Despite the bravado of official propaganda, Moscow is aware of these challenges and seeking to address them. The Russian solutions might take on various characteristics. The standard toolkit of counting on growing “Ukraine fatigue” and the advent of Russian-friendly officials in the West will certainly be in play. The Kremlin’s primary solution, however, is likely to be based on strengthening links between the military-industrial complex and the central economy, as Presidential Press Secretary Dmitry Peskov has noted (RIA Novosti, May 12). Moscow hopes to do so without falling into the Soviet trap of increasing military spending to the point that it could break the back of the resource-dependent, drawback economy. 

These considerations look to have been partly behind the decision to appoint Andrei Belousov, a professional economist and civilian who had not been implicated in any major scandals, to Russian defense minister (see EDM, May 16, June 20). In his new capacity, Belousov is likely to concentrate on two main functions: 

1. He has placed an emphasis on fighting against the most avid and detrimental forms of corruption. In effect, the charges and allegations of corruption in the Ministry of Defense paved the way for the replacement of former Defense Minister Sergei Shoigu and the arrests of some of his closest associates. Belousov is expected to wage a war on both previously recorded major cases of corruption and pursue new ones, in which such powerful figures as Tatiana Moskalkova, commissioner for human rights; Tatiana Golikova, deputy prime minister for social policy, labor, healthcare, and pensions; Vyacheslav Volodin, chair of the Russian State Duma; and Viktor Khristenko, Eurasian Economic Commission chair, could potentially become targets of prosecution (Dzen.ru, July 15). 
2. Belousov has begun efforts to consolidate all the internal financial resources necessary to continue the war against Ukraine at the current level of intensity. Back in 2021, Belousov was a strong proponent of imposing additional taxes on businesses that enjoy high profit margins (primarily, the metallurgical industry). In 2023, he spoke in favor of a windfall tax on large businesses (Overclockers.ru, June 16). The new defense minister is also considering increasing tax rates for those Russians whose monthly income exceeds 200,000 rubles ($2,330), which would concern 3.2 percent of Russia’s labor force (Izvestiya, May 28). While economically viable, this measure also has an ideological undertone, as it is designed to consolidate public opinion in favor of the current incumbent regime as one of “social welfare.” 

Aside from these measures, it is still unclear what other strategies Belousov and his team might employ. A deeper analysis of internal debates in Russia suggests that part of the Russian elite is promulgating the need to pursue the “mobilizational model of development” (mobilizatsionnaya model razvitiya). Unlike concepts such as a “mobilization economy” or “war economy,” this model presents a more complex phenomenon that is premised on three pillars (Noviye Izvestiya, January 9,  2023): 

1. Ideology—This builds on socialist policy and seeks to do away with two groups within Russia’s financial elite that comprise the so-called “fifth column.” One group is the “oligarchic elite” (interestingly, reference is made to Ukraine as an example that Russia could follow), and the second is “effective managers” (i.e., active stalwarts of a liberal economic model). 
2. Economics—Here, unlike what Patrushev and like-minded figures have proposed, the argument is that the Russian economy should pivot toward an economic model that comprises elements of a market and planned economy with the state delegating special responsibilities and competencies to manufacturing and production. 
3. Managerial Component—Drastic administrative-political changes are needed in following this model of development, which also calls for the formation of a State Defense Committee headed by the Russian president. 

Similar ideas have been voiced by ultraconservative economists and public figures, including Sergey Glazyev (Zakupki-digital.ru, January 10, 2023). Undoubtedly, these ideas and the actual measures that have already been undertaken by Belousov and his team put some members of Russia’s ruling elite, and even certain segments of Russian society, in a precarious position, primarily due to systemic corruption among the Russian elite and a lack of political will to tackle it. In turn, this may contribute to growing internal frictions between different segments of Russian society. 

Expected Societal Response 

The future of the Russian economy largely depends on the course of Russia’s war against Ukraine and developments in the domestic situation. While many economists and Russian experts argue that Moscow will not follow the socioeconomic model and, thus, political path of the Soviet Union, the current realities point to a trend of greater state involvement in the economy and suppression of freedoms. If such trends continue, a wider societal response is almost certain.

At the top level, many experts have argued that the Russian elite are becoming increasingly divided between the “hawks,” primarily members of the siloviki and ultraconservative elites determined to continue the war, and the “technocrats” (also known as the “second generation” of Putin’s elite), who are said to be gathering around the figure of Katerina Tikhonova (Putin’s daughter) (RBC, July 24). While neither group considers the West to be Russia’s ally or argues for the end of the war on Ukrainian/Western terms, the latter group wants to minimize losses and freeze the conflict. It is quite clear that these intra-elite fissures exist and may be growing. Nabiullina’s most recent statements, in which she states that the “resources of the Russian economy are exhausted” and that the economy cannot operate under the same model for much longer, showcase this divide (BBC Russian Service, July 30). For now, no signs of a “palace revolution” in Russia are looming, but depending on how the situation on the battlefield evolves and how the fighting might affect the Russian economy, that could change. 

At the grassroots level, the situation is complex. On the one hand, Russia has experienced a surge of instability in the regions, including in the Sakha Republic (Yakutia) (Unian, January 24; see EDM, April 16, July 23), Bashkortostan (Unian, January 19; see EDM, February 8, 27), and the North Caucasus (DW, October 29, 2023; see EDM, June 25, August 6). The growing instability has coincided with increased xenophobia directed at foreign migrant workers, especially from Central Asia, and reached its zenith following the Crocus City Hall terrorist attack in March (Interfax, March 22; see EDM, March 26, 28). These developments, however, were not directly linked to Russia’s war, though Moscow tried to cast blame on Ukraine and the West. The majority of Russian experts argue that there should be no expectation of any major social upheaval triggered by the war (Current Time, March 12). This may be true to some degree, given the traditionally high levels of social apathy and indifference in Russian society as well as high levels of distrust in Ukraine and the West, which Putin’s regime has cultivated for years (Kremlin.ru, July 21, 2021). Nevertheless, the cumulative effect of worsening socioeconomic conditions, mounting war losses, simmering ethnic tensions, and skyrocketing violent crime and alcoholism may trigger increased calls within Russian society for transformative changes. This outcome, however, may only become possible with the proper application of internal and external pressures on the Kremlin (see EDM, January 29). 

Conclusion

Ukraine and its Western partners can now consider an effective way of capitalizing on the current structural problems within the Russian economy and society by adopting actionable measures aimed at decimating Moscow’s ability to wage war. As one Russian outlet puts it, “Beyond any doubt, sanctions, restructuring the economy for war needs, and distortion of economic stimuli are incurring serious damage on Russia’s economy, yet their effect will only be visible in the long term. The mid-term perspective, however, will not pose a critical threat capable of making Putin stop the war” (Istories.media, June 5). This signals a need for more targeted measures to trigger more immediate damage to Russia’s war machine. Nevertheless, so long as the current political regime stays in place, the Kremlin seems determined to continue its war despite the economic and domestic costs. Russian Foreign Minister Sergey Lavrov recently confirmed this attitude when he stated that if the West favors the outcome of the war to be decided on the battlefield, Russia is ready (Kommersant, May 13). 

On top of that, the Putin regime is unable to stop the war, as such an action would be painful for the Kremlin. Most foreign businesses are gone, and the distortion of the central budget toward heavy military and defense spending will likely leave the economy in shambles. Additionally, the need to reintegrate hundreds of thousands of military men (many disabled) into normal civilian life could have a calamitous impact on Russian society, as seen in the resurgence of “Afghan syndrome” among returning veterans from Ukraine (see EDM, October 25, November 13, 2023). Thus, the Putin regime is not planning to stop the war anytime soon, which is evident from Russia’s doubling of one-time payments for contract soldiers to the tune of 400,000 rubles ($4,644), among other measures (Pravo.gov.ru, July 31; see EDM, August 7). 

Therefore, Kyiv’s Western partners would do well to consider a multidimensional approach to destroy Russia’s ability to wage war and facilitate Ukraine’s ultimate victory in reclaiming its sovereign territory and driving the Russian occupiers out. 

• Economic sanctions will need to stay intact and expanded in some cases, irrespective of what Russian propaganda and their agents in the West claim. A recent positive development was the extension of sanctions to non-oil sectors, hitting Russia’s uranium, diamond, and metals industries (see EDM, July 23). Yet, more can be done to target the oil sector, as it remains the Kremlin’s main cash cow. One option is to reconsider implementing a more stringent price cap, which Poland earlier proposed at $30 per barrel (RIA Novosti, November 24, 2022). If adopted, this measure could result in an avalanche of accompanying problems, including the further devaluation of the ruble and Moscow’s inability to cover imports of microchips and other essential components. This, in turn, would curb Russia’s ability to properly maintain and repair its critical infrastructure, which could stir discontent in Russian city centers and the economically depressed regions during the winter (The Moscow Times, June 26). 
• Moscow’s dire labor shortage can also be exploited, as related measures will be key in fomenting Russia’s economic bankruptcy and paralysis of critical sectors (see EDM, January 16, June 27). The crisis in the labor market can be accelerated in two ways. First, Russia must continue to suffer heavy casualties in Ukraine. This gives further impetus to the West supplying Ukraine with the necessary arms and munitions in a comprehensive and timely manner. If casualty rates stay high or grow further, the Russian state will have to seriously consider the much-feared idea of a mass mobilization, which will significantly hurt the Russian economy and almost certainly result in yet another wave of emigration. Second, in terms of the information space, the West can do more to shine a light on surging xenophobia and interethnic conflict within Russian society that disproportionately targets Central Asian migrants and the peoples of the North Caucasus to discredit the Kremlin’s ability to maintain order (see EDM, May 15). 
• Ukraine’s ability to conduct long-range strikes against critical energy infrastructure and military targets deep within Russian territory is crucial (see EDM, June 3, July 15). As oil remains Moscow’s key export commodity and personnel shortages strain the workforce, the Kremlin will find it increasingly more difficult to maintain the war effort and quell societal strife if its main source of revenue is crippled by Ukraine’s precision strikes. 

At the time of writing, it remains abundantly clear that the majority of Russia’s political elite remain determined to continue the war. This reality means that over the next year, the main developments will happen on the battlefield, giving added weight to the West’s continued military support of Ukraine. Nevertheless, mounting economic problems could further disrupt Russian society at the elite and grassroots levels and hamper Moscow’s ability to wage war. Thus, a combination of heightened military and sanctions pressure would likely lead to the Kremlin committing more mistakes in hopes of managing economic malaise and social strife, which could exacerbate the cracks beginning to form in the Kremlin’s hold on power.