1 00:00:00,560 --> 00:00:05,560 Since Russia invaded Ukraine in 2022, it's economy has surpassed 2 00:00:05,560 --> 00:00:09,400 most expectations. Last year, Russia's economy grew 3 00:00:09,400 --> 00:00:13,520 more than the United States and Europe, and on top of that, 4 00:00:13,520 --> 00:00:16,200 Russian unemployment is at a record low. 5 00:00:16,520 --> 00:00:20,200 Vladimir Putin and Russian supporters have hailed this as a 6 00:00:20,200 --> 00:00:24,360 great success, and as of evidence that Western sanctions 7 00:00:24,400 --> 00:00:29,440 didn't work, it's worth noting that the Ukrainian economy also 8 00:00:29,440 --> 00:00:33,000 outgrew the United States and Europe over the last two years, 9 00:00:33,160 --> 00:00:38,600 having grown 2.9% last year and 5 1/2% the year before. 10 00:00:38,840 --> 00:00:42,800 But of course, no one is trying to claim that business is 11 00:00:42,800 --> 00:00:45,960 booming in Ukraine. With some carefully chosen 12 00:00:45,960 --> 00:00:49,920 numbers, you can put a very positive spin on the growth of 13 00:00:49,920 --> 00:00:53,320 the Russian economy. And the reason for this is that 14 00:00:53,320 --> 00:00:56,440 wartime economies are very different to these time 15 00:00:56,440 --> 00:00:59,800 economies, and so we have to analyze them differently. 16 00:01:00,120 --> 00:01:04,120 While wars are destructive of physical and human capital, 17 00:01:04,319 --> 00:01:07,600 these don't show up in national income accounting. 18 00:01:07,800 --> 00:01:11,520 Spending on weapons production and the vast spending required 19 00:01:11,520 --> 00:01:15,560 to reorient Russia's economy, which used to face towards the 20 00:01:15,560 --> 00:01:19,960 West and now faces towards the East, boosts GDP. 21 00:01:20,640 --> 00:01:24,480 As impressive as the GDP growth rates in Ukraine over the last 22 00:01:24,480 --> 00:01:29,320 two years might at first sound, they come in the wake of a 30% 23 00:01:29,320 --> 00:01:33,720 decline in GDP in 2022 when the country was invaded. 24 00:01:34,080 --> 00:01:37,400 A huge amount of Ukrainian infrastructure has been 25 00:01:37,400 --> 00:01:41,640 destroyed by Russia, all of which will need to be rebuilt at 26 00:01:41,640 --> 00:01:45,000 great expense. According to an analysis by the 27 00:01:45,000 --> 00:01:49,440 European Parliament, if Ukraine was able to maintain its recent 28 00:01:49,440 --> 00:01:54,280 growth rates, it's real GDP would only return to its pre war 29 00:01:54,280 --> 00:01:59,360 level by 20-30. GDP, or Gross domestic product, 30 00:01:59,600 --> 00:02:04,120 is defined as the total monetary value of all of the Finnish 31 00:02:04,120 --> 00:02:08,120 goods and services produced within a country's borders in a 32 00:02:08,120 --> 00:02:11,200 specific time period, usually a year. 33 00:02:11,440 --> 00:02:15,000 And it's often used as a scorecard of a country's broad 34 00:02:15,000 --> 00:02:20,040 economic help in wartime. When Russia spends, let's say, a 35 00:02:20,040 --> 00:02:23,760 billion dollars on tanks, economists would measure their 36 00:02:23,760 --> 00:02:26,800 value at the price the government paid for them, so 37 00:02:26,800 --> 00:02:31,200 that $1 billion worth of tanks would add a billion dollars to 38 00:02:31,200 --> 00:02:34,560 Russian GDP. If those tanks were destroyed 39 00:02:34,560 --> 00:02:39,080 the next day in Ukraine, as many of them have been, this spending 40 00:02:39,080 --> 00:02:42,520 won't have added any real value to the Russian economy. 41 00:02:42,760 --> 00:02:46,720 But the waste never shows up in the GDP calculation. 42 00:02:47,120 --> 00:02:51,640 For this reason, a lot of the GDP growth is illusory. 43 00:02:52,080 --> 00:02:56,040 As Sergey Guriev of London Business School described it in 44 00:02:56,040 --> 00:03:00,880 the FT earlier this year, this type of wartime spending on 45 00:03:00,880 --> 00:03:04,880 quickly destroyed tanks is equivalent to just printing a 46 00:03:04,880 --> 00:03:08,360 billion dollars and handing it over to the people who work in 47 00:03:08,360 --> 00:03:12,640 the tank factory or to it's shareholders without anything 48 00:03:12,640 --> 00:03:15,840 being produced. So on paper it might look like 49 00:03:15,840 --> 00:03:20,520 Russia is producing a lot of GDP, but a lot of that GDP is 50 00:03:20,520 --> 00:03:24,520 destroyed weapon systems and payments made to either wounded 51 00:03:24,520 --> 00:03:27,880 Russian soldiers or the families of dead soldiers. 52 00:03:28,160 --> 00:03:31,800 He points out that all of Russia's growth since the start 53 00:03:31,800 --> 00:03:35,240 of the war is concentrated in the military sector. 54 00:03:35,880 --> 00:03:42,000 Russian defense spending went from 3% of GDP to almost 7% 55 00:03:42,000 --> 00:03:46,080 after the start of the war, a massive increase in spending. 56 00:03:46,320 --> 00:03:50,520 But that's only the start. War costs are not limited to 57 00:03:50,520 --> 00:03:53,440 just paying soldiers and spending on weapons. 58 00:03:53,680 --> 00:03:57,120 Expenses for treating the injured show up as healthcare 59 00:03:57,120 --> 00:04:00,200 expenses. Expenses for debris removal and 60 00:04:00,200 --> 00:04:04,240 repair of infrastructure fall under housing and utilities. 61 00:04:04,520 --> 00:04:08,160 None of these are counted under the narrowly defined military 62 00:04:08,160 --> 00:04:10,520 spending section of the Russian budget. 63 00:04:10,800 --> 00:04:14,760 But a huge amount of this other spending wouldn't have happened 64 00:04:14,760 --> 00:04:18,120 without the war. There have been huge costs 65 00:04:18,120 --> 00:04:21,600 associated with the switch from trading with Europe and the 66 00:04:21,600 --> 00:04:25,800 United States to trading with China and India, which Russia 67 00:04:25,800 --> 00:04:29,600 has been forced to do since Western sanctions were imposed. 68 00:04:29,920 --> 00:04:33,320 This is required building transportation infrastructure 69 00:04:33,440 --> 00:04:37,840 and reorienting supply chains. All of this spending shows up in 70 00:04:37,840 --> 00:04:41,760 GDP too, but without the invasion of Ukraine it would 71 00:04:41,760 --> 00:04:45,840 have been unnecessary. According to the FT, compared 72 00:04:45,840 --> 00:04:50,360 with 2021, which was the last pre war year, Russian budget 73 00:04:50,360 --> 00:04:55,280 expenditures have increased by 20% and the state's share in the 74 00:04:55,280 --> 00:05:00,240 Russian economy has reached an estimated 50 to 70%. 75 00:05:00,680 --> 00:05:04,840 Russia's central bank identifies government spending as the main 76 00:05:04,840 --> 00:05:09,840 driver of GDP growth. War related spending in Russia 77 00:05:10,000 --> 00:05:14,800 rose from around 23% of the budget pre invasion to almost 78 00:05:14,800 --> 00:05:20,080 40% by last year. Sergey Guriev argues that most 79 00:05:20,080 --> 00:05:24,080 of Russia's war spending has the same effect as helicopter money, 80 00:05:24,280 --> 00:05:27,800 as huge amounts of money were pumped into the economy while 81 00:05:27,800 --> 00:05:30,440 nothing of lasting value was produced. 82 00:05:30,680 --> 00:05:34,240 When there's more cash in the economy for the same output, 83 00:05:34,480 --> 00:05:38,200 this causes inflation. And Russian inflation has been 84 00:05:38,200 --> 00:05:41,960 so extreme that thieves have even been breaking into stores 85 00:05:41,960 --> 00:05:44,960 to steal butter. While inflation has cooled 86 00:05:44,960 --> 00:05:48,840 almost everywhere else in the world, it's been roaring hot in 87 00:05:48,840 --> 00:05:53,200 Russia. Consumer prices rose 10.3% year 88 00:05:53,200 --> 00:05:58,120 on year in March, well above the central bank's target of 4%. 89 00:05:58,560 --> 00:06:01,680 The prices of fruit and vegetables have risen by more 90 00:06:01,680 --> 00:06:04,680 than 20% on average in the past year. 91 00:06:04,960 --> 00:06:09,080 Potatoes have almost doubled in price, and butter prices rose 92 00:06:09,080 --> 00:06:14,200 26% last year, prompting some stores to keep it in plastic 93 00:06:14,200 --> 00:06:18,880 boxes under lock and key. Russians on the ground don't 94 00:06:18,880 --> 00:06:22,320 appear to believe the official inflation rate, and while this 95 00:06:22,320 --> 00:06:25,560 can be the case everywhere in the world, there's maybe more 96 00:06:25,560 --> 00:06:28,720 reason to believe that people are right in Russia than 97 00:06:28,720 --> 00:06:32,200 elsewhere. Inflation is calculated using 98 00:06:32,200 --> 00:06:35,840 the prices of a fixed basket of goods and services. 99 00:06:36,080 --> 00:06:40,480 The basket is adjusted over time to adjust for changing consumer 100 00:06:40,480 --> 00:06:44,520 tastes, and when an item is no longer available, a similar 101 00:06:44,520 --> 00:06:49,280 replacement item is substituted. But often the replacement item 102 00:06:49,280 --> 00:06:52,960 is of different quality, which can affect the calculation. 103 00:06:53,280 --> 00:06:57,040 Statistics agencies attempt to adjust for these quality 104 00:06:57,040 --> 00:07:00,480 differences, but that task becomes near impossible possible 105 00:07:00,480 --> 00:07:04,200 in a wartime economy like Russia's, where so many items 106 00:07:04,200 --> 00:07:08,440 previously imported from Western nations are now being imported 107 00:07:08,440 --> 00:07:11,760 from either China and India or being made at home. 108 00:07:11,960 --> 00:07:15,880 It can be extremely difficult to compare quality differences like 109 00:07:15,880 --> 00:07:19,720 this, but a lot of reporting out of Russia indicates that the 110 00:07:19,720 --> 00:07:23,320 replacement goods are often of lower quality, meaning that 111 00:07:23,320 --> 00:07:27,400 people are spending more money and getting lower quality goods. 112 00:07:28,040 --> 00:07:31,160 The Russian central bank announced after their March 113 00:07:31,160 --> 00:07:35,400 meeting that while inflationary pressures are easing, they would 114 00:07:35,400 --> 00:07:38,600 still keep interest rates at 21%. 115 00:07:39,280 --> 00:07:42,680 There are a few factors that explain Russia's high inflation. 116 00:07:42,880 --> 00:07:46,800 Firstly, with the West having tightened sanctions over time 117 00:07:46,920 --> 00:07:50,880 and with the ruble depreciating, imported goods were getting both 118 00:07:50,920 --> 00:07:54,280 more expensive and more difficult to acquire. 119 00:07:54,720 --> 00:07:58,480 Secondly, conscription. Russians fleeing the country to 120 00:07:58,480 --> 00:08:02,640 avoid conscription and soldiers dying on the battlefield have 121 00:08:02,640 --> 00:08:07,040 caused severe labor shortages which pushed up wages in all 122 00:08:07,040 --> 00:08:10,920 sectors of the economy. The high wages being paid to 123 00:08:10,920 --> 00:08:14,720 keep munitions factories running around the clock, which produce 124 00:08:14,720 --> 00:08:18,640 goods that the average Russian citizen has no need for, has 125 00:08:18,640 --> 00:08:21,560 crowded out non wartime production. 126 00:08:22,040 --> 00:08:25,800 Civilian businesses had to pay higher and higher wages to 127 00:08:25,800 --> 00:08:30,120 attract workers, which increases their operating costs and gets 128 00:08:30,120 --> 00:08:33,240 passed on as more expensive goods and services. 129 00:08:33,240 --> 00:08:37,880 In Russia, all of this means that unemployment fell to around 130 00:08:37,880 --> 00:08:42,559 2%, which is the lowest on record in Russia, and last year 131 00:08:42,559 --> 00:08:47,640 nominal pay rose by 18%. While the central bank was 132 00:08:47,640 --> 00:08:51,520 hiking interest rates to slow an overheating economy, the 133 00:08:51,520 --> 00:08:55,760 government was implementing massive fiscal stimulus spending 134 00:08:55,760 --> 00:08:58,720 on defence, welfare and infrastructure. 135 00:08:59,240 --> 00:09:02,600 Russian business owners, in particular those selling to the 136 00:09:02,600 --> 00:09:05,840 government who were making a lot of money from government 137 00:09:05,840 --> 00:09:09,920 procurement, found it difficult to travel abroad and began 138 00:09:09,920 --> 00:09:14,080 spending more money in Russia. This strong demand, according to 139 00:09:14,080 --> 00:09:18,200 the Russian central bank, still exceeds companies capacities to 140 00:09:18,200 --> 00:09:21,760 expand supply. So with more money chasing fewer 141 00:09:21,760 --> 00:09:27,080 goods, prices go up and up. The government stimulated other 142 00:09:27,080 --> 00:09:29,160 parts of the Russian economy, too. 143 00:09:29,440 --> 00:09:33,920 When war broke out in early 2022, the central bank hiked 144 00:09:33,920 --> 00:09:38,680 interest rates above 20% and put capital controls in place so 145 00:09:38,680 --> 00:09:41,240 that people couldn't get their money out of Russia. 146 00:09:41,600 --> 00:09:45,680 In order to keep the people happy, the Kremlin introduced A 147 00:09:45,680 --> 00:09:49,960 Mortgages for Everyone program, which offered cheap loans for 148 00:09:49,960 --> 00:09:53,880 new construction that charged half the going interest rate. 149 00:09:54,400 --> 00:09:58,640 the FT says that the authorities had to demonstrate that despite 150 00:09:58,680 --> 00:10:02,320 all the shocks and sanctions, people would still be able to 151 00:10:02,320 --> 00:10:05,560 buy an apartment. This massive interest rate 152 00:10:05,560 --> 00:10:09,840 differential put in place a huge incentive to borrow and build 153 00:10:09,840 --> 00:10:12,960 new homes, which drove record sales. 154 00:10:13,320 --> 00:10:18,960 The total value of mortgages held in Russia grew 35% in 2023 155 00:10:18,960 --> 00:10:22,560 alone, before the government finally listened to the central 156 00:10:22,560 --> 00:10:24,840 bank and shut the programme down. 157 00:10:25,480 --> 00:10:29,560 This mix of huge fiscal stimulus, which is unevenly 158 00:10:29,560 --> 00:10:33,400 applied throughout the economy, combined with a tight labour 159 00:10:33,400 --> 00:10:37,200 market and then offset with extremely high interest rates 160 00:10:37,440 --> 00:10:42,080 brought about a spending boom. The mix of contrasting policies 161 00:10:42,080 --> 00:10:46,280 left Russia with a turbo charged but extremely unbalanced 162 00:10:46,280 --> 00:10:50,200 economy. These economic stresses are not 163 00:10:50,200 --> 00:10:53,480 that unusual in wartime economies, where you see 164 00:10:53,480 --> 00:10:57,200 increased central planning and the military competing with the 165 00:10:57,200 --> 00:11:00,880 civilian sector for both workers and resources. 166 00:11:01,320 --> 00:11:05,440 The guns versus Badr economic concept is often used to 167 00:11:05,440 --> 00:11:10,240 describe this trade off between military spending or guns and 168 00:11:10,240 --> 00:11:12,840 social welfare spending, or Badr. 169 00:11:13,080 --> 00:11:17,200 It illustrates the dilemma faced by governments when allocating 170 00:11:17,200 --> 00:11:20,760 limited resources between military and domestic needs. 171 00:11:21,280 --> 00:11:25,480 While Russia's low unemployment rate can be spun as a positive, 172 00:11:25,720 --> 00:11:29,560 it's really a signal that the civilian sector is short on 173 00:11:29,560 --> 00:11:31,960 labour. The Russian government has 174 00:11:31,960 --> 00:11:35,960 boosted the pay for volunteer soldiers so that they can avoid 175 00:11:35,960 --> 00:11:38,840 conscription. This caused all sorts of 176 00:11:38,840 --> 00:11:42,440 problems at the start of the war, when young Russian men fled 177 00:11:42,440 --> 00:11:44,960 to neighboring countries to avoid the draft. 178 00:11:45,280 --> 00:11:49,480 The most recent pay increase means Russian volunteer soldiers 179 00:11:49,480 --> 00:11:53,720 now earn five times the average nominal income in Russia. 180 00:11:54,360 --> 00:11:58,280 Russian soldiers have never earned as much before, and on 181 00:11:58,280 --> 00:12:01,600 top of this, soldiers families have seen a boost in the 182 00:12:01,600 --> 00:12:06,440 compensation received for losing their sons, such that 6% of 183 00:12:06,440 --> 00:12:10,760 Russia's budget is estimated as being spent to pay families of 184 00:12:10,760 --> 00:12:14,040 the dead and wounded. Russia may have all the 185 00:12:14,040 --> 00:12:18,000 appearances of being in an economic boom, but it's not 186 00:12:18,000 --> 00:12:20,880 driven by the market. It's instead driven by 187 00:12:20,880 --> 00:12:24,520 government spending. The high inflation means that 188 00:12:24,520 --> 00:12:28,720 the central bank has to keep monetary policy very tight, but 189 00:12:28,720 --> 00:12:33,200 with an interest rate of 21% it's extremely difficult for 190 00:12:33,200 --> 00:12:36,640 private non defence companies to do business. 191 00:12:36,960 --> 00:12:41,080 Even Russia's largest weapons manufacturer Roztech, which is 192 00:12:41,080 --> 00:12:45,000 benefiting from government contracts, is complaining about 193 00:12:45,000 --> 00:12:48,400 the high interest rates which make export contracts 194 00:12:48,440 --> 00:12:52,080 unprofitable for them. According to the Moscow Times, 195 00:12:52,320 --> 00:12:57,080 corporate bankruptcy surged 20% in Russia last year and this 196 00:12:57,080 --> 00:13:01,760 trend is expected to continue. A recent report by Russia 197 00:13:01,760 --> 00:13:06,000 analyst Craig Kennedy highlights the huge growth in Russian 198 00:13:06,000 --> 00:13:12,360 corporate debt, which has soared by 71% since 2022 and dwarfs new 199 00:13:12,360 --> 00:13:14,400 household and government borrowing. 200 00:13:14,760 --> 00:13:18,960 According to the FT, Putin has commandeered the Russian banking 201 00:13:18,960 --> 00:13:23,440 system, forcing banks to lend to chosen companies at preferential 202 00:13:23,440 --> 00:13:27,800 terms, and the result has been a flood of below market rate 203 00:13:27,800 --> 00:13:32,400 credit to favour businesses. They describe this as massive 204 00:13:32,400 --> 00:13:35,400 money printing hidden on the balance sheets of state 205 00:13:35,400 --> 00:13:38,840 controlled banks which may eventually need to be bailed 206 00:13:38,840 --> 00:13:41,200 out. This is all being done, they 207 00:13:41,200 --> 00:13:45,200 say, in an effort to conceal a growing budget deficit. 208 00:13:45,720 --> 00:13:48,840 The Russian economy is struggling much more than it 209 00:13:48,840 --> 00:13:52,680 might at first appear to be, and the Economist reported earlier 210 00:13:52,680 --> 00:13:55,760 this week that it's rapidly getting worse. 211 00:13:56,040 --> 00:13:59,640 They highlight lower growth in military spending and high 212 00:13:59,640 --> 00:14:04,520 interest rates as likely to Ding GDP growth, but say that the 213 00:14:04,520 --> 00:14:08,640 biggest problem for Russia is the recent decline in oil prices 214 00:14:08,880 --> 00:14:13,160 combined with a slowdown in China, Russia's biggest export 215 00:14:13,160 --> 00:14:16,760 destination. In March, Russian oil and gas 216 00:14:16,760 --> 00:14:20,840 revenue fell by around 17% year on year. 217 00:14:21,000 --> 00:14:25,040 On April 30th, the Russian Finance Ministry increased the 218 00:14:25,040 --> 00:14:33,640 budget deficit estimate for 2025 to 1.7% of GDP from 0.5% after 219 00:14:33,640 --> 00:14:38,040 reducing its forecast for energy revenues by 24%. 220 00:14:38,920 --> 00:14:42,320 There are a few ways that Russia's been paying for the war 221 00:14:42,520 --> 00:14:46,080 using oil and gas revenues, spending down the sovereign 222 00:14:46,080 --> 00:14:50,200 wealth fund, allowing government liabilities like pension costs 223 00:14:50,200 --> 00:14:54,200 and government worker wages to decline in real terms, while 224 00:14:54,200 --> 00:14:57,520 keeping military and police wages high to keep the 225 00:14:57,520 --> 00:15:01,280 leadership safe. Last year, Russia announced 226 00:15:01,280 --> 00:15:05,840 large tax hikes and significant spending cuts on support for 227 00:15:05,840 --> 00:15:09,800 small businesses, education, and other social spending. 228 00:15:10,480 --> 00:15:15,000 As soon as Russia invaded Ukraine in 2022, approximately 229 00:15:15,000 --> 00:15:18,200 half of Russia's foreign currency and gold reserves, 230 00:15:18,360 --> 00:15:23,200 which amounted to over $300 billion, were frozen by Western 231 00:15:23,200 --> 00:15:25,880 countries. It's hard to know what will 232 00:15:25,880 --> 00:15:28,160 happen with those reserves in the long run. 233 00:15:28,440 --> 00:15:32,320 No interest is accumulating on the frozen reserves for Russia, 234 00:15:32,480 --> 00:15:35,840 which amounts to billions of dollars that they've lost out 235 00:15:35,840 --> 00:15:40,120 on, and it's unclear as to how, when and under what conditions 236 00:15:40,120 --> 00:15:42,320 the reserves will be returned to Russia. 237 00:15:42,800 --> 00:15:47,760 Losing access to these reserves was a big hit for Russia, and if 238 00:15:47,760 --> 00:15:51,520 they had access to that $300 billion, they could have spent 239 00:15:51,520 --> 00:15:55,440 it on soldiers and weapons and would likely have been far more 240 00:15:55,440 --> 00:16:00,440 successful in attacking Ukraine. Russian spending, shown here in 241 00:16:00,440 --> 00:16:04,120 the orange bars, hasn't led to much debt, as government 242 00:16:04,120 --> 00:16:08,680 spending has mostly been offset by federal revenue, shown here 243 00:16:08,680 --> 00:16:12,040 with the blue bars. This means that Russia's budget 244 00:16:12,040 --> 00:16:16,360 deficit is under 3%. When we look at how much oil and 245 00:16:16,360 --> 00:16:21,080 gas has brought in, you can see how important energy exports are 246 00:16:21,080 --> 00:16:25,440 to the Russian economy and also how harmful a fall in the price 247 00:16:25,440 --> 00:16:29,520 of oil would be. Russia is the third largest oil 248 00:16:29,520 --> 00:16:33,160 producer in the world, just behind the United States and 249 00:16:33,160 --> 00:16:36,560 Saudi Arabia. My friend Minosha talking heads 250 00:16:36,560 --> 00:16:40,680 Macro argues that before the Russian invasion of Ukraine, 251 00:16:40,880 --> 00:16:44,080 Russia suffered from what economists call the Dutch 252 00:16:44,080 --> 00:16:47,240 disease. This term originated from the 253 00:16:47,240 --> 00:16:51,920 economic impact of the discovery of vast natural gas reserves in 254 00:16:51,920 --> 00:16:57,000 the Netherlands in the 1960s. This discovery caused a surge in 255 00:16:57,000 --> 00:17:00,640 the Dutch economy's income, leading to a rise in the value 256 00:17:00,640 --> 00:17:05,319 of its currency and a decline in the competitiveness of other 257 00:17:05,319 --> 00:17:08,839 economic sectors. Countries rich in natural 258 00:17:08,839 --> 00:17:12,800 resources, like Russia, often struggle to translate this 259 00:17:12,800 --> 00:17:15,839 wealth into widespread economic prosperity. 260 00:17:16,280 --> 00:17:20,119 The Dutch disease can worsen this problem by concentrating 261 00:17:20,119 --> 00:17:23,920 wealth in the resource sector while weakening other parts of 262 00:17:23,920 --> 00:17:27,040 the economy. Because a lot of goods can be 263 00:17:27,040 --> 00:17:30,720 manufactured anywhere in the world, a strong currency which 264 00:17:30,720 --> 00:17:34,480 was brought about by factors other than high productivity, 265 00:17:34,680 --> 00:17:37,760 makes all other production within that country 266 00:17:37,960 --> 00:17:42,800 internationally uncompetitive. When a country has a natural 267 00:17:42,800 --> 00:17:46,480 resources windfall, the best thing to do is to invest that 268 00:17:46,480 --> 00:17:50,240 wealth into productivity enhancing goods so that all 269 00:17:50,240 --> 00:17:54,760 sectors of the economy can grow. The goal is to focus on economic 270 00:17:54,760 --> 00:17:58,960 activity that can lead to even greater economic activity. 271 00:17:59,240 --> 00:18:02,840 Russia has instead mostly focused on oil and gas 272 00:18:02,840 --> 00:18:07,240 production or on energy intensive industries that take 273 00:18:07,240 --> 00:18:10,760 advantage of the availability of cheap energy within the country. 274 00:18:11,800 --> 00:18:15,720 Although Russia has an educated workforce, there's been very 275 00:18:15,720 --> 00:18:19,880 little focus on making the most of those workers by let's say, 276 00:18:20,040 --> 00:18:24,600 making higher tech products, as it's simply easier to focus on 277 00:18:24,600 --> 00:18:28,440 oil and gas production, which doesn't really require a lot of 278 00:18:28,440 --> 00:18:31,960 innovation as the underlying technology for commodity 279 00:18:31,960 --> 00:18:35,720 extraction hasn't changed very much over the years. 280 00:18:36,120 --> 00:18:40,480 Because of the Dutch disease, Russian productivity was never 281 00:18:40,480 --> 00:18:44,520 great and the economy wasn't very impressive before the war. 282 00:18:44,800 --> 00:18:48,160 But Minoj points out that the transition of Russia's 283 00:18:48,160 --> 00:18:52,640 production resources to wartime use was much easier than the 284 00:18:52,640 --> 00:18:56,160 transition to a services driven economy would have been. 285 00:18:56,840 --> 00:19:00,040 In a country that needed to produce high tech or more 286 00:19:00,040 --> 00:19:03,640 complex products to bring in money to pay for tanks and 287 00:19:03,640 --> 00:19:07,640 soldiers, it would have been more difficult to finance a war 288 00:19:07,680 --> 00:19:10,320 when cut off by the international community. 289 00:19:10,760 --> 00:19:14,200 It would also be more economically harmful to shut 290 00:19:14,200 --> 00:19:17,680 down those types of businesses and send highly productive 291 00:19:17,680 --> 00:19:20,000 workers to the front line to fight. 292 00:19:20,560 --> 00:19:24,240 Russia was able to continue producing oil and selling it, 293 00:19:24,440 --> 00:19:28,560 working around sanctions with a shadow fleet of oil tankers and 294 00:19:28,560 --> 00:19:32,000 selling more to China and India than they did in the past. 295 00:19:32,400 --> 00:19:37,120 Before the war, India bought 1% of its oil imports from Russia. 296 00:19:37,400 --> 00:19:42,400 Today, they source between 35 and 45% of their oil imports 297 00:19:42,400 --> 00:19:44,920 from Russia. So a massive change. 298 00:19:45,280 --> 00:19:48,840 While the transition to a war economy may have been easy for 299 00:19:48,840 --> 00:19:52,400 Russia, the question we're left with is how quickly can Russia 300 00:19:52,400 --> 00:19:56,080 return to a normal economy when the war ends? 301 00:19:56,600 --> 00:19:59,120 The place where the sanctions have been hurting Russia the 302 00:19:59,120 --> 00:20:03,720 most is that no one really wants to invest in Russia anymore, or 303 00:20:03,720 --> 00:20:06,840 is able to invest in Russia even if they wanted to. 304 00:20:07,360 --> 00:20:10,040 The country has been cut off from the inflow of new 305 00:20:10,040 --> 00:20:14,720 technology, capital products, new investment and new ideas, 306 00:20:14,920 --> 00:20:18,360 and should a peace deal be struck, all of that will need to 307 00:20:18,360 --> 00:20:21,480 be restarted. Having been cut off from the 308 00:20:21,480 --> 00:20:25,200 rest of the world, Russian businesses have had next to no 309 00:20:25,200 --> 00:20:29,800 competition and thus have had no incentive to produce cheaper or 310 00:20:29,800 --> 00:20:32,520 better goods during that time frame. 311 00:20:32,600 --> 00:20:36,040 Foreign businesses have had to compete and have been forced to 312 00:20:36,040 --> 00:20:40,800 improve, while Putin can quite likely use Russia's natural 313 00:20:40,800 --> 00:20:44,720 resources well to sustain his war for a very long time. 314 00:20:45,200 --> 00:20:49,640 As time goes by, a slow decay occurs in the quality of Russian 315 00:20:49,640 --> 00:20:52,240 businesses. Productivity gets worse and 316 00:20:52,240 --> 00:20:57,080 worse over time and the economy hollows out as the country just 317 00:20:57,080 --> 00:21:01,080 sells oil to pay for the war and the standard of living slowly 318 00:21:01,080 --> 00:21:04,440 declines. The longer this war goes on, the 319 00:21:04,440 --> 00:21:07,760 more Russia stands still while the rest of the world moves 320 00:21:07,760 --> 00:21:11,800 forward with real growth rather than growth driven by government 321 00:21:11,800 --> 00:21:15,280 spending and where new technologies are developed that 322 00:21:15,280 --> 00:21:19,560 boost productivity. While Russian oil and gas might 323 00:21:19,560 --> 00:21:23,560 be needed, buyers who used to source other goods from Russia 324 00:21:23,680 --> 00:21:27,880 before the war have now found new suppliers and have no reason 325 00:21:27,880 --> 00:21:30,360 to start buying from Russian firms again. 326 00:21:30,680 --> 00:21:34,360 As Russia stagnates, it's smartest and most productive 327 00:21:34,360 --> 00:21:38,640 workers who haven't left yet will leave for opportunities in 328 00:21:38,640 --> 00:21:42,480 the rest of the world. The type of GDP that Russia has 329 00:21:42,480 --> 00:21:46,760 generated in recent years has been entirely driven by military 330 00:21:46,760 --> 00:21:51,280 spending, and in peacetime Russia can't grow its way out of 331 00:21:51,280 --> 00:21:55,480 its problems as that spending will stop when the war ends and 332 00:21:55,480 --> 00:21:58,880 there are no sustainably profitable businesses left. 333 00:21:59,480 --> 00:22:04,080 Often when wars end, you see a reconstruction boom, but very 334 00:22:04,080 --> 00:22:07,640 little Russian infrastructure has been destroyed, so not much 335 00:22:07,640 --> 00:22:10,720 needs to be rebuilt. While Russia isn't as 336 00:22:10,720 --> 00:22:14,680 militarized as the Soviet Union was during the Cold War, the 337 00:22:14,680 --> 00:22:18,640 demilitarization that occurred when the Cold War ended brought 338 00:22:18,640 --> 00:22:23,000 about a huge economic shock as nothing replaced the military 339 00:22:23,000 --> 00:22:25,760 economic activity when it abruptly ended. 340 00:22:25,960 --> 00:22:30,040 It took years for munitions factory workers to retrain to 341 00:22:30,040 --> 00:22:35,080 work in other businesses. Putin will struggle to normalize 342 00:22:35,080 --> 00:22:39,160 the Russian economy after the multiyear lending boom where 343 00:22:39,160 --> 00:22:43,120 state control banks were forced to finance defense companies at 344 00:22:43,120 --> 00:22:46,760 subsidized rates. Preferential loans to defence 345 00:22:46,760 --> 00:22:49,920 companies, agricultural businesses, construction 346 00:22:49,920 --> 00:22:55,080 companies and mortgage borrowers now make up about 16% of banks 347 00:22:55,080 --> 00:22:58,400 total portfolios, according to the Bank of Russia. 348 00:22:58,720 --> 00:23:03,200 This raises the prospect of a post war wave of defaults if 349 00:23:03,200 --> 00:23:06,360 defence spending falls and the economy slows. 350 00:23:07,080 --> 00:23:10,960 The Russian economy has already started slowing and can be 351 00:23:10,960 --> 00:23:14,880 expected to struggle if energy prices fall any further. 352 00:23:15,160 --> 00:23:21,520 The IMF expects growth of 1.3% this year and 1.2% next year. 353 00:23:22,120 --> 00:23:25,520 While the US government has discussed lifting sanctions on 354 00:23:25,520 --> 00:23:29,240 Russian energy sector, the European Union and the United 355 00:23:29,240 --> 00:23:32,920 Kingdom don't appear to be planning to follow suit, at 356 00:23:32,920 --> 00:23:36,640 least not until Russia is no longer seen as a security 357 00:23:36,640 --> 00:23:38,960 threat. Thanks for tuning into this 358 00:23:38,960 --> 00:23:41,640 week's podcast. If you found it interesting, I'd 359 00:23:41,640 --> 00:23:45,800 really appreciate it if you sent a link to a friend, as podcasts 360 00:23:45,800 --> 00:23:49,040 tend to grow by word of mouth. Thanks, as always to my 361 00:23:49,040 --> 00:23:52,480 supporters on Patreon. Talk to you again next week. 362 00:23:52,600 --> 00:23:52,960 Bye.