Sanctions against Russia will not work

The problem with applying economic sanctions to Russia is that it hurts us more than it hurts them. The better news - or worse news depending on which side you are on - is that Russia is in effect imposing sanctions on itself. In the short term it faces greater disruption. There is no question about that. But in addition by sharpening the economic fault lines between Russia and the West, it will make it harder to cope with the long-term headwinds it inevitably faces.

The short term first. We have to be realistic about what we are doing. The measures so far announced – the freezing of some bank accounts and the like – are tokens. If the West really wanted to damage the Russian economy it would cut its imports of gas and raw materials, and that is not going to happen any time soon.
The US talks of ratcheting up sanctions but the EU has made it pretty clear that it will not do anything that hurts its own economies. To put it disagreeably, Europe is in enough of a mess at the moment not to want to hurt itself more.

But Russia is hurting too. Consider this. On Monday the deputy economy minister Sergei Belyakov said that the economic situation "bears clear signs of a crisis". The rouble has fallen by more than 9 per cent against the dollar this year, and to protect it official interest rates were put up earlier this month from 5.5 per cent to seven per cent. Inflation is over 6 per cent and the capital outflow in the first quarter may be as high as $70bn.

The economy grew by only 1.3 per cent last year and forecasts for this year have been sharply scaled down. Thus VTB Capital, based in Moscow, has just forecast zero growth this year. Indeed it is possible that the economy may already be in recession, and if it isn't, the events of the past few days may cause one.

All this is dismal news. It is not the time to pick a fight with your main markets and while Russia can sell its raw materials at a discount elsewhere, any shading down in exports to Europe will inevitably slow growth further. Any further capital flight will mean there is less money to be spent at home.

If Russia faces a tough year it also faces a tough few decades. There are three main headwinds. First there is demography. Russia's population is forecast to shrink faster than that of any major country in the world. The UN estimates that it could fall by about 40 per cent in the years to 2050.

That is in contrast to the US, where population is expected to rise by about one-third. The reasons are varied and complex: why do Russians have such small families, why do men die so young?

But leave aside the social and societal reasons for this and just focus on the economic consequences. A sharply falling population means that Russia will become less important in the world.

The second headwind is over-dependence on energy and raw material exports. In very round numbers about half the government's revenue comes directly or indirectly from the primary sector, which in turn provides nearly 80 per cent of the country's exports.

If you add oil and gas together, Russia is the world's largest producer. Yet the US, thanks to shale production, is projected to pass it in a couple of years' time.

Further, it is plausible that the real price of oil and gas will not rise further, maybe even fall. So the country's present strength becomes a less strong suit.

Strategically Russia has to develop other exports, other ways of earning its living in the world. It has plenty of talented and well-educated people to help it do so, but the system makes it hard, even impossible, to deploy their competence.

That leads to the third headwind: governance. Economic management does not have to be perfect but it has to be good enough to discourage your best brains leaving. Russia is not only suffering a capital drain; it is also confronting a brain drain.

It also has to attract foreign skills and funding where needed. Yet it remains very difficult place in which to do business. Anyone investing there has to be aware that they may have their investments stolen.

That is profoundly damaging because inward investment not only brings capital but also the expertise and access to markets attached to that capital. Arguably expertise and market access matter more than cash.

It is not for foreigners to tell Russia how to reform its economic governance, but to get inward investment that is what the country has to do.

The events of the past few weeks have made it that much harder to justify inward investment. If the locals are bringing their money out by the truck-load, why should a foreign investor put money in?

The prize out there is that the EU can help Russia and Russia can help the EU. The tough bit is engineering an appropriate relationship that enables this to happen.

The Independent


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Reader Comments

Wow, you didnt bother to fact check at all did you, sir?

You state the UN population projection from 2005, failing to check whether that figure had been updated or not.

"First there is demography. Russias population is forecast to shrink faster than that of any major country in the world. The UN estimates that it could fall by about 40 per cent in the years to 2050."

It seems you have a bias towards presenting things as bleakly as humanly possible. I wont bother fixing all of your errors, but this is the most egregious one and should be mentioned. Here is the correct information, youre welcome:

"The population of Russia peaked at 148,689,000 in 1991, just before the breakup of the Soviet Union. Low birth rates and abnormally high death rates caused Russias population to decline at a 0.5% annual rate, or about 750,000 to 800,000 people per year from the mid-1990s to the mid-2000s. The UN warned in 2005 that Russias then population of about 143 million could fall by a third by 2050, if trends did not improve.
The Russian state statistics service Rosstat had more optimistic forecasts in 2009, whose Medium variant predicted that Russias population would only fall to 139 million by 2030 (Low: 127 million; High: 147 million). Furthermore, in 2008 one demographic analyst (correctly) predicted a resumption in population growth by 2010, and of natural population growth by 2013"

Present day Russia under Putin is more interested in getting back the glorious days of erstwhile Soviet Union. No wonder, it may resort to expansionist measures to achieve that glory. Rulers are not much interested in future of Russia where freedom, economic as well as human , will be the buzzword.