Is Russia outperforming the EU or simply borrowing from its own future?

Leo Tolstoy’s famous maxim about families could easily be adapted to express an important truth about contemporary geopolitics: the economies of the EU and Russia are both unhappy, but each in its own way. 

Europe is currently suffering from structurally-elevated energy prices, record-high interest rates, and industrial stagnation. Russia, meanwhile, is enduring high inflation, a tight labour market, and — thanks to Western sanctions imposed following its full-scale invasion of Ukraine in February 2022 — severe difficulties accessing high-tech goods.

Happiness, however, is a relative concept. And, according to several standard economic metrics, it would appear at first glance that Europe’s economy is considerably unhappier than that of its Eastern neighbour.

According to the International Monetary Fund’s (IMF) latest forecast, Russia’s GDP is expected to grow by 2.6% this year: 1.5 percentage points higher than the Fund’s October forecast. The eurozone economy, meanwhile, has had its projected growth cut from 1.2% to 0.9%. 

Prima facie, the fact that the Russian economy is set to expand nearly three times faster than the European one this year should be a major cause for concern for European policymakers.

Such worries are plausibly exacerbated by the fact that Russia’s economy grew six times more than the eurozone’s economy last year (3% vs 0.5%), as well as by the fact the specific sectors in which the Russian economy is performing particularly well — industry and manufacturing — are strategically crucial sectors in which Europe’s economy is performing especially poorly. 

Experts contacted by Euractiv, however, painted a significantly rosier picture of Europe’s economic prospects than of Russia’s ones.

Janis Kluge, a senior associate at the German Institute for International and Security Affairs (SWP), noted that Europe still has “all the ingredients for long-term growth”, including “some really competitive industries”.

Conversely, Russia — which has lost hundreds of thousands of young people to emigration or directly to the war over the past two years — has “lost its future”.

Kluge said Europe does not have the resource wealth of Russia but the latter is “actually in a structurally much worse situation than the EU. [It is] isolated from its most important traditional trading partners and partially isolated from those countries that it calls its friends or friendly countries”.

“You see Turkish and Chinese banks wanting to distance themselves from Russia. All of this creates huge costs for the Russian economy and makes it much harder to develop.”

Kluge attributed Russia’s relative “resilience” to Western sanctions — the 13th package of which was announced earlier this week — to three key factors: high commodity prices, especially for fossil fuels; the “flexibility” of Russia’s market economy, which he said facilitated a “decentralised effort” by thousands of businesses to circumvent sanctions; and – possibly the most important driver – the Kremlin’s enormous war-related fiscal stimulus.

Russia’s military expenditure is in fact set to rise to 6% of GDP this year, up from 3.9% last year and 2.7% in 2021.

“If European governments were spending as much as Russia is right now, we would see really fast growth in the European Union,” Kluge said.

“It would be a completely different picture. It might not be sustainable, [but] basically, the European economy would be booming right now.”

Inflated woes

While cushioning the impact of sanctions, however, Russia’s massive military expenditure is also feeding into one of its key economic vulnerabilities — its surging inflation rate.

“In Russia, inflation is now structural,” said Alexander Kolyandr, financial analyst and former emerging markets strategist at Credit Suisse.

“It is plagued by the fact that the main engine of Russian growth is government spending.”

His words were echoed by Kluge, who said inflation was going to be one of the symptoms of Russia’s deteriorating economic prospects.

“As long as inflation is low, the regime can compensate for many things by simply spending more, creating public demand. But if inflation is high, then there are some real trade-offs and some real concerns,” Kluge said.

Last week, Russia’s state-run statistics agency, Rosstat, reported that year-on-year headline inflation was 7.4% in January, the same as in December – more than three times higher than in April last year, when it stood at just 2.3%.

By contrast, eurozone inflation is estimated to have fallen to 2.8% last month, down from 2.9% in December and from a 10.6% peak in October 2022. 

Core inflation, which strips out volatile energy and food prices and is considered a better estimate of underlying price pressures, paints an even less flattering picture of Russia’s economy: while its core monthly inflation has risen every month since April 2023 to peak at 7.15% in January, the monthly figure for the eurozone has fallen every month since July, reaching 3.3% last month.

‘An impossible trilemma’: An economic model borrowing from the future?

Considering this backdrop of rising inflation, Russian president Vladimir Putin’s commitment to funding the war means he is now facing an “impossible trilemma”, said Alexandra Prokopenko, a nonresident scholar at the Carnegie Russia Eurasia Center and a former Russian central banker.

The researcher argued the Russian leader is juggling three mutually-exclusive targets: continuing to fund the war in Ukraine; maintaining the facade of business-as-usual for the broader population through “lavish” spending on wages, business- and consumer-tax exemptions and consumer goods imports, and safeguarding microeconomic stability, mainly through low inflation.

Achieving the first and second goals translates into higher costs – to the detriment of the third; while lowering inflation would entail curbing expenditures, barring the other two objectives, Prokopenko said.

“I believe that the choice will be made in favour of lowering the living standards of the population, because macroeconomic stability is a cornerstone for [Putin]” she added.

Overall, Kolyandr was similarly pessimistic about Russia’s long-term prospects. “My opinion is that the current economic model cannot exist over the long run,” he said.

“The growth of 2023 and 2024 is growth borrowed from the future. When the day of reckoning will come, I don’t know. But history tells us that payback always comes.”

[Edited by Anna Brunetti/Zoran Radosavljevic]

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