According to Nalon & Partners, it is estimated that Russian public spending since the beginning of the war has amounted to USD 360 billion, but 75% of the industrial sectors are shrinking or collapsing vertically, thanks to Western sanctions.
The sanctions imposed on Russia by Western countries are unprecedented and far exceed any sanctions ever imposed in history. To name but a few: half of Russia’s bank reserves in foreign currency, amounting to $580 billion, have been seized and almost all Russian banks have been cut off from international transfer systems, which means Russian companies cannot pay and collect from foreign suppliers. Nearly two thousand individuals and companies have been sanctioned, there has been a naval and air blockade, and the import and export ban on many manufacturing and technology products has been lifted.
Six months after coming into force, for several Western observers, the sanctions against Russia are not working. Even in Italy, several politicians argue that the sanctions damage the national economy more than Russia. On the other hand, according to data from the International Monetary Fund, Russia’s GDP fell by only 6% instead of the 15% predicted by economists: less than half. Moreover, record commodity prices are contributing to Russia’s record trade balance: thanks to stratospheric increases in fuel prices, Russia has doubled its currency receipts compared to a year ago.
In reality, according to Nalon & Partners, a Bologna-based consulting firm, sanctions on Russia work and work well. ‘Economic indicators,’ they explain at Nalon & Partners, ‘cannot be read on their own but must be contextualised with other indicators. Only then is it possible to get a picture of the health of an economy. And the Russian one is bad’.
“To begin with, suffice it to say that the 6% drop in GDP is a serious sign. Because, in reality, Russian GDP was supposed to grow.”
‘In war,’ they explain at Nalon & Partners, ‘the GDP of a country, which does not actually conduct it on its own soil, must explode. Because, apart from the death and destruction it brings, war is the biggest public expenditure a state can make. Since Russian factories and cities are not affected by the destruction of production facilities, as is the case in Ukraine, the Russian situation is similar to that of the United States during World War II. The country is at war but on someone else’s territory, and the production facilities of others are destroyed. The US, by way of comparison, had a GDP growth of between 20% and 30% per year during the Second World War, thanks to government spending on the war. So much for a 6% contraction!’
And the Keynesian model has shown that if I invest billions in public spending on military salaries and orders to the war industry, the aggregate demand curve rises, and the GDP, of which public spending is a part, must, of necessity, rise.
Although the figures are secret, American estimates show that Russia spends between $500 million and $700 million a day on its war, paying the army and ordering new weapons from the industry. This is public spending. If we take the lowest estimate, to date, Russia has already made a public expenditure of around 90 billion dollars, money injected into its economy in the form of orders and salaries and financed, for the most part, by the positive balance of trade (the famous gas). But one must also consider the indirect effects of public spending, i.e. the induced effects that $90 billion brings into an economy.
Let’s consider, as an average, the marginal propensity to consume equal to ¾ (i.e. of every extra dollar that came to the Russian economy from public spending due to the war, 75 cents is spent on consumption by workers and business owners and the remainder saved). It means that the multiplier effect on the GDP would amount to $360 billion to date. A real injection of money should give us the biggest GDP growth ever recorded, as in the US during World War II, they conclude at Nalon & Partners.
Moreover, Russia’s GDP has to grow, not only because of the largest cash injection in its history, but also because of its record net export balance. Thanks to rising fuel prices, Russia’s net trade balance doubled. If we take April 2022, Russian exports amounted to USD 63 billion; the year before, it was only USD 36 billion (World Bank data).
The Russian economy should, on paper, be in splendid shape, and it would be, were it not for Western sanctions, the ones that are assumed to be ineffective. A country’s GDP is made up of consumption + investment + government spending + net exports. As public spending and net exports go, Russia is doing great. Why is GDP falling?
For two reasons, explain Nalon & Partners.
The first is the interest rate imposed by the Russian Central Bank to try to halt the collapse of the rouble, a purely political and image purpose in which the currency’s value and the economy’s real growth are chosen. The high-interest rate counterbalanced the mega-investment in public spending due to the war (an effect known as ‘crowding out’, i.e. the contraction of aggregate demand induced by an increase in the interest rate and the consequent decrease in investment), reducing the beneficial effects on the economy. This shows – contrary to those who claim that the Russian Central Bank managed the crisis well – that the Central Bank further damaged the country’s growth with a monetary policy bent on politics.
The second reason for the GDP fall is the consumption and investment collapse. If, in fact, two out of the four items that make up the GDP are growing disproportionately (public spending and net exports), the other two (consumption and investment) must, of necessity, have suffered a monstrous collapse in order not only to bring GDP growth to zero but also to have brought it into negative territory.
This is confirmed by data from Rosstat, Russia’s Istat. It is the official data from the Kremlin.
The data for industrial production for July 2022 show a slump in some vertical sectors. Of 24 industries, 18 have contracted, ranging from minus 2% in the beverage sector to minus 60% in the automotive sector. Minus 60%, we repeat, according to Russian data (90% according to US data). A contraction that should not be there in an economy with $360 billion of newly injected public spending. Instead, a contraction comes from the flight of Western companies and the closure of factories. From MacDonald to Ikea, from Siemens to Shell – hundreds of Western companies have left Russia; on the other hand, the embargoes on technology prevent Russian factories from resuming production on their own, and this is particularly visible in high-tech sectors such as the automotive industry.
To those who say that sanctions don’t work, just answer: ‘imagine what happens in Italy if 75% of industries drop production all together. And some by 60% in one fell swoop’.
For the six industries that have held up, we see the effects of war investments (the famous 90 billion in direct government spending in the form of orders to industry). The metal industry grew by 30% (tanks), the pharmaceutical industry by 17% (casualties) and clothing by 3% (uniforms).
The collapse of industrial production in about 75 per cent of a country’s industries inevitably brings the collapse of consumption. Companies produce less and consumers buy less. This collapse is documented indirectly by the deflation that has hit Russia.
Since the beginning of August, the consumer price index has fallen by about 0.40 per cent, and inflation has fallen by 0.80 per cent. That is, prices are falling. This is not as good news as it might sound. It means that consumption is falling, often not due to consumers’ will but due to a reduced supply of goods and services. And a drop in consumption combined with a drop in industrial production means a deflationary and recessionary spiral where industries invest less and less and produce less and less, consumers consume less and less, and workers stay at home.
If the purpose of sanctions is to hit the Russian economy, sanctions on Russia are effective, they conclude at Nalon & Partners. Not for nothing, Russia demands their easing as the first topic in any negotiation.
However, whether the sanctions will have a political consequence in Russia and on its government is another matter altogether.
