There are those who argue that western nations’ economic sanctions against Russia have not worked or are unsatisfactory. They are overlooking the effect of capital depreciation, which is a silent killer of economies, businesses, and minds. There is every reason to assume Russia's capital stock is depreciating and that the consequences will become more apparent as the war drags on. In Ernest Hemingway's 1926 novel, The Sun Also Rises, there is a conversation: "How did you go bankrupt?" Bill asked. "Two ways," Mike said; "Gradually and then suddenly."

Capital depreciation may sound boring, but I still spent quite a few months of my thesis work contemplating the concept.1 Simply put, all capital wears out over time if it is not continuously reinvested. Imagine a student who just crammed all the material for an exam and then, after the exam party, doesn't remember much or even recall which courses they studied twenty years later. The student's capital is human capital. If we don't stay updated and continuously learn new things, our human capital diminishes.

Another example is metal that rusts or machines that wear out if not lubricated. Many machines can run for a long time without issues. If we stop servicing all the escalators in the Stockholm subway, some may continue working after several years, while others will break down next week. Climbing up to ground level when all the escalators are out of order at the Odenplan commuter train station gives even the moderately fit a real workout. For pensioners, it's even more challenging. One broken escalator out of two is manageable but crowded. If both are broken, the problem is massive.

A final example: if a taxi company buys 1,000 cars this year, it's unlikely that all the cars will still be running in the third year. Some will crash. Others will have design flaws, and some will be stolen. To maintain a functional fleet, maintenance and new purchases are necessary. Looking at the Russian army and society, it seems that corruption is devouring much of the necessary investment.

We should not be surprised that we don't see significant effects in the Russian economy, beyond the fact that many figures probably don't add up. However, we will likely begin to see an accelerating decline soon. One year is a short time, but two years is a different story.

If I were to lose my job, I could sustain my consumption through savings for a year or two. The people in Russia probably have savings to rely on for a year, but the second year will be more challenging. During the initial stages of the war, they must have believed that the troops would be home by Christmas. The Russian state may have also kept production up through subsidies and grants to companies as a transitional solution, but now the transition seems more like a downfall.

Russia unexpectedly stopped publishing most of the details of its national budget. 2 The federal budget deficit reached the equivalent of $41 billion during the first five months of 2023. The deficit would correspond to SEK 133 billion for the Swedish national budget, which is a substantial amount. Last year, the Nordic countries' economies were larger than Russia's, and the Nordic economies are growing while Russia's GDP is falling. 3 Russia may account for about 10 percent of the EU's total economy.

Russia is planning budget cuts of around 10 percent, although some budget items are protected.4 Unprotected expenses exclude items considered to be direct expenditures ordered by the president and the government, which include social spending for war veterans and families with children. However, universities and schools will receive less funding, which will harm human capital in the long term. Railways will not be properly maintained, something we Swedes have experience with (not that I believe Russian railway maintenance is any better).

Boettke (2002)5 found that the failure to predict the fall of the Soviet Union was due to three factors:

  1. Economists ignored evidence other than measurable statistics.

  2. The elegance of the formal structure of central planning, balancing input and output, and,

  3. Preoccupation with aggregated measures of economic growth instead of detailed microeconomic analysis of fundamentals.

All three factors, but especially the third, should be applied to the analysis of Russia. Boettke makes me wonder why so many people in the West, who probably should know better by now, trust data from authoritarian governments engaged in an information war? Russia's economy is in a death spiral, and what we are witnessing is:

  1. Decreased growth: investment drives economic growth. By investing in new projects, technology, or capital goods, production increases, and new jobs are created, replacing the grinding gears of creative destruction. Without sufficient investment, the economy can stagnate or even shrink in size.

  2. Decreased employment: investments typically provide opportunities for new jobs. When companies reduce their investments, it can lead to layoffs and increased unemployment. For example, according to Russian sources, Russian car production fell by 67 percent in 2022. The comparative figure from January to January 2023 was minus 77 percent.6

  3. Long-term competitiveness: by failing to make continuous investments, companies and industries can fall behind in technological advancements and competitiveness. It can be challenging to recover when the economy starts to rebound if the opportunity to invest in new technology or modernization has been missed. If the Russian economy is alive, it is likely that they are not investing in maintenance as they cannot afford it, and parts cannot be imported.

  4. Negative spiral: the lack of investment can create a negative spiral. When companies reduce their investments, the demand for goods and services also decreases. This can further reduce companies' revenues and profitability, diminishing their ability to make investments. This can create a vicious cycle of decreased investment, decreased production, and decreased employment. The Russian state is burning vast amounts of money, and it is doubtful that they can sustain businesses for another year.

During the war, we have seen that much of the Russian equipment did not function as advertised, and their stock of military materials was depleted and poorly maintained, with parts stolen over the years and procurement budgets lining private pockets. Do we have any reason to trust Russia's aggregated figures on the economy when weaknesses in individual sectors seem devastating?

There are no exact figures on how many people have left Russia, but estimates vary from hundreds of thousands to several million. In May 2023, the UK Ministry of Defence estimated 1.3 million people leaving Russia in 2022.7 Other estimates from various sources confirm this trend. Forbes magazine cited sources inside the Russian authorities as saying that between 600,000 and 1,000,000 people left the country in 2022. 8 Additionally, up to 200,000 young men have been killed, and many more have been injured. If that doesn't impact the economy, it would be surprising. The country's birth rates have been in decline since 1994, when Russia was estimated to have 149 million citizens. By the start of 2022, its population was estimated to be 145.6 million.9

We are probably witnessing the beginning of the end. Initially, Putin imposed draconian taxes on both companies and individuals leaving Russia after the invasion before abandoning that method and instead arbitrarily seizing money and property. Putin has abandoned all responsible fiscal policy by running record budget deficits, printing record amounts of money out of thin air, forcing Russian banks and individuals to buy almost worthless Russian debt, and using Russia's hundreds of billions in reserved funds, mortgaging Russia's future. 10

An unserviced car may still run, but when you need the brakes to work 100 percent, any failure can lead to a crash. An economy is a system with billions of daily decisions, and it is impossible to know what cascading effects a small breakdown can have. What will remain of Russia's GDP at the end of the year is likely something that historians twenty years from now will have a better grasp of than what the Russian state presents.

This article was written by Jonas Grafström. Jonas is a Swedish researcher and academic with the Ratio Institute think tank, the Oxford Institute for Energy Studies, Luleå University of Technology, and the AI-Econ-Lab at Örebro University. He is a writing fellow with Young Voices Europe.

References

1 Technological Change in the Renewable Energy Sector : Essays on Knowledge Spillovers and Convergence.
2 Russia Covers Up Key Budget Spending Data as War Swells Deficit.
3 Nordens gemensamma ekonomi är nu större än hela Rysslands.
4 Russia planning 10% spending cut for 2024 budget redistribution, Vedomosti reports.
5 Calculation and Coordination.
6 Russian car production slumped to lowest since Soviet times in 2022.
7 Why are people leaving Russia, who are they, and where are they going?
8 ‘Hopeless Situation’: Thousands Of Russians Flee To Neighboring Countries To Avoid Putin’s Military Draft.
9 Dramatic Population Drop in Russia, as War, COVID and Emigration Exacerbate Declining Births.
10 How the Russian economy self-immolated in the year since Putin invaded Ukraine.