Why The Russian Economy Isn’t Collapsing
Western leaders undervalued the size and global reach of the Russian economy
Headlines concerning the collapse of the Russian economy under sanctions have been many and varied, although more recently observations have been made that sanctions imposed by the West aren’t working to the extent intended.
Writing this from Moscow, I can observe that supermarkets are full, there are no shortages, and gasoline is US$3.1 a gallon. That compares with Washington at US$4.99, London at US$8.16, Berlin at US$6.73 and Rome at US$7.31.
Why has the effect of sanctions upon Russia been so widely misunderstood? It’s a complicated question yet comes with a simple answer: politicians aren’t economists.
The French economist Jacques Sapir has recently explained the mistakes politicians have made when assessing Russia, with the United States constantly stating the Russian economy as being insignificant when compared to the US and being about the same size of Italy’s. That is a miscalculation.
According to Sapir, the reason for this disparity is exchange rates. If you simply convert Russia’s GDP from rubles to dollars for comparison, it would be seen as an economy as large as Italy’s. However, such comparisons are meaningless without adjusting for purchasing power parities, (PPP) which account for productivity and living standards, and thus per capita welfare and resource use. In fact, PPP is the preferred measure of most international institutions, from the IMF to the OECD.
So what happens when the PPP methodology is used to compare the actual size of the Russian economy?
Doing so reveals a much larger and significant beast – it becomes clear that Russia’s economy is rather more similar to the German economy at about US$4.4 trillion versus Germany’s US$4.6 trillion.
This means that the West’s politicians has grossly under estimated Russia’s economy as being a small, somewhat sickly European economy to being close to the largest in Europe and one of the largest in the world.
Concerning Russia, Sapir also asks: “What is the share of the services sector compared to the share of the products and industry sector?” In his view, today’s services sector is grossly overvalued compared with the industrial sector and commodities such as oil, gas, copper, and agricultural commodities, all of which Russia possesses in massive amounts.
If we reduce the importance of services as a proportion of the global economy, Sapir says, “Russia’s economy is much bigger than Germany’s, and accounts for up to 5-6% of the world economic output.”
That puts Russia on a par with Japan rather than Italy.
This makes intuitive sense. When times are tough, it is common knowledge that it is more valuable to provide people with the things they need, such as food and energy, rather than intangibles such as entertainment or financial services.
When a company like Netflix trades at a price-to-earnings ratio three times higher than Nestle, the world’s largest food company, that is more likely a reflection of frothy markets than actual reality. Netflix is a great service company, but as long as some 800 million people in the world are undernourished, Nestle still offers more value. And Netflix shares and earnings have indeed begun to slide post covid as consumers concentrate on the essentials. (Netflix also recently exited the Russian market).
There are lessons to be learned from this – the current situation in Ukraine helps to clarify values on what have been regarded as “archaic” aspects of the modern economy, such as industry and commodities, but whose prices have soared this year; compared with overvalued services and “technology” whose value has recently diminished, such as Netflix and Facebook.
There is more. The size and importance of the Russian economy has been further distorted by ignoring global trade flows, which Sapir estimates Russia’s portion “may account for 15%”.
For example, while Russia is not the world’s largest oil producer, it has been the largest oil exporter, surpassing even Saudi Arabia. The same is true of many other basic products, such as wheat, the world’s most important food crop, of which Russia controls about 19.5% of global exports, as well as nickel (20.4%), semi-finished iron (18.8%), platinum (16.6%) and frozen fish (11.2%).
This means that Russia has such an important position in the production of so many basic commodities, that along with several other countries, is in fact a key part of the globalized supply chain.
The United States has largely failed to acknowledge this and persuaded the European Union to follow the same thinking over sanctions while grossly underestimating both the size of the Russian economy and the role Russia has in global trade. The US has had success in imposing “maximum sanctions” on countries like Iran and Venezuela but trying to cut Russia off from world markets has resulted in and will continue to bring about a huge restructuring of the global economy that may take several years to absorb.
In fact, by controlling large sections of the oil, gas, food and other global commodities, the sanctions pain bought to bear upon Russia by the United States and its Allies has shifted to the originators of these – and their own populations.
Russia Briefing is written by Dezan Shira & Associates. The firm has 28 offices throughout Eurasia, including China, Russia, India, and the ASEAN nations, assisting foreign investors into the Eurasian region. Please contact us at email@example.com for Russian investment advisory or assistance with market intelligence, legal, tax and compliance issues throughout Asia.