Russia’s crisis as an opportunity to break with the past

In the wake of the 2012 presidential election, President Vladimir Putin published an article in Russia’s leading business daily, Vedomosti, on the economic policy he intended to pursue if the Russian people would let him serve another term in the Kremlin. Putin promised to launch a broad modernization of the Russian economy. As a result, the share of high-tech industries was supposed to be 1.5 times higher by 2020 and the real average salaries in the economy were supposed to be 1.7 times higher.

In 2015, Russia is severely lagging behind these goals. The country’s economy is in crisis: real salaries have fallen by 8.8% since the beginning of this year. The size of the economy shrunk by 3.6% in the same period, while annual inflation had risen to 15.6% by July. That’s according to data from a recent report from the Economic Development Ministry. As a result, the number of poor people in Russia has spiked by 3.1 million, reaching 22.9 million total, or 15.9% of the population, according to the State Statistics Service.

The country’s Economic Development Ministry is expecting Russia’s GDP to contract by 3.3% this year and then grow by 1-2% in 2016. Given that the economy grew by only 1.3% in 2013 it is almost certain that by the next presidential election the country will have an economy that is about the same size as the one it had in 2012. Russia’s share in the world economy, currently at 3.3%, will shrink.

Following the absorption of Crimea, and the confrontation with the West that ensued, the Russian people have rallied around Putin. Yet, over the last 15 years they have also become used to steadily increasing living standards that are regarded as Putin’s main achievement as the undisputed leader of Russian politics. As the “Crimea effect” evaporates with time and people’s lives get harder, Putin could face challenges even before the next presidential election in 2018.

The fall in real incomes and shrinking GDP were largely provoked by sectoral sanctions, imposed on Russia by Western states in response to the Ukraine crisis. Yet despite these difficulties, the Russian economy has been sluggish since 2013. The level of investment peaked in October 2012, long before the Ukraine crisis, and has been declining since. In 2015, investments have fallen by 5.9%, reflecting a deteriorating investment climate. Construction has also been declining since 2013, before the international conflict unraveled, and has fallen by 7.7% since the beginning of this year. At the same time, unemployment remains low at 5.6% reflecting Russia’s specific peculiarity: people would rather accept lower salaries, fewer working hours or go on a forced vacation, but remain officially employed.

The fact that the Russian economy was lagging behind the world’s average rates of economic growth at the time when no sanctions were imposed and the price of oil was hitting all-time highs means that the old model of its development has become obsolete. Russia will have to work hard and find a new model that will make it develop further. The question is what will force Putin, the Russian government and society at large to find this new model and conduct necessary reforms?

If we put aside raw numbers and look at daily life in Russia, the crisis is visible but not dramatic. Although many commercial premises are vacant on the main streets of Moscow and St. Petersburg, and that foreign-produced clothing or electronics have become luxuries, life has not changed that much.

Some effects of the crisis can, however, be seen outside of the country. Fewer Russians can afford to travel to foreign countries such as Italy or France for vacation. At the same time, Russian resorts, such as Sochi, have been overbooked. While many critics predicted that Sochi’s $51 billion infrastructure would be vacant, the crisis suddenly changed the game.

This crisis has hit the various Russian regions in a different ways. The government did not cut expenditures on the military-industrial complex, so the regions that produce weapons (Bryansk, Tula, Mari-El and others) are in a good shape. Russian agriculture has been one of the few industries that has been growing steadily in recent years, so regions of southern Russian (Stavropol, Krasnodar, Rostov, Belgorod) are better off too. The oil and gas-producing regions of Tyumen, Yamal and Sakhalin will receive more rubles for fewer dollars for their hydrocarbons, and therefore will not be affected very much.

The investment-intensive regions of Kaluga and Tatartstan, however, will be hit hard as the sources of cheap loans have been exhausted. In contrast to the previous crisis, Russia’s main cities of Moscow and St. Petersburg will be more severely impacted by the current one. The ruble devaluation has decreased the purchasing power of its residents and hence has affected the banking, retail and services sectors of local economies.

During the first decade of the 21st century, Russia developed more rapidly than most other countries in the world. However, over the past five years this growth has withered away and the country is now in a recession.

One of Russia’s chief reformers of the last two decades, former Finance Minister Alexei Kudrin, who has now turned into a government critic, predicted in an op-ed, published in Kommersant – another leading Russian newspaper – that after this crisis in its present state, the Russian economy will only be able to grow at a rate of 0.5-1.5%. This will mean that Russia’s share in the world economy will shrink to 2.6% by 2020 ­– the lowest since the fall of the Soviet Union. Meanwhile, Russia cannot afford to be sluggish. It faces serious demographic challenges, as there are fewer young people to replace the aging workforce.

In the past Russian politics have meddled in economics – the country’s leadership has ventured on a more assertive foreign policy and spent money on expensive projects, such as the Winter Olympics or the upcoming World Cup. Today Russia faces a choice, either it will reform its institutions – cut its monopolies, privatize mammoth state companies, reform the judiciary and spend more on infrastructure ­– or the sluggish economy will start to affect its politics, as has already happened in late 1980s-1990s.