War and Sanctions Threaten to Thrust Russia’s Economy Back in Time

More than nine months after the invasion, neither the war effort nor the economy has collapsed, and the economic pain is still limited for many Russians.

· More than 1,000 multinational companies curtailed operations in Russia because of its invasion of Ukraine.

· the most coordinated and deepest economic sanctions in modern history

· Russian industries are highly dependent on Western components.

· Russia’s government was better prepared to withstand the sanctions than many in the West expected.

· A combination of high oil revenues, large currency reserves and an expert team of economic officials has allowed Putin to soften the blow.

Valery Volodin, a welder at a sprawling Volkswagen plant in western Russia, relaxed for most of the summer at his dacha, or weekend house, planting his garden and looking after his children. Volodin, 41, had little choice: The car factory closed down in March, joining more than 1,000 multinational companies curtailed operations in Russia because of its invasion of Ukraine.

Since then, he has been sitting at home while Volkswagen looks for a buyer. He goes into the plant, in Kaluga’s industrial zone, once a month to collect 50,000 rubles, about $800, a payment required by Russian labor law that is the equivalent of two-thirds of his previous salary.

His experience is playing out across Russia for hundreds of thousands of workers after the West imposed sweeping economic sanctions that were intended to hobble Moscow’s ability to wage war and to undercut public support for President Vladimir Putin.

More than nine months after the invasion, neither the war effort nor the economy has collapsed, and the economic pain is still limited for many Russians. Putin has avoided any substantive domestic pressure that would threaten his leadership. But the impact of what some have described as the most coordinated and deepest economic sanctions in modern history is evident in communities across Russia — and the worst may be yet to come.

The sanctions have stymied Russia’s faltering attempts to modernise its economy along Western lines and to catch up to European living standards after the fall of the Soviet Union, said Vladislav Inozemtsev, the Washington-based director of the Center for Post-Industrial Studies, a Russian research group. That has dimmed the hope that the country could become a modern, prosperous nation in the near term.

The most visible and dramatic impact has been on manufacturing, a sector that employs 10 million Russians and that has been the centerpiece of Putin’s ambitious program to diversify the economy away from reliance on oil and gas exports. The auto industry accounts for a large percentage of those workers: Carmakers employ 300,000 Russians, according to the country’s statistics agency, and the association representing their interests say that up to 3.5 million more work in related industries.

By September, output in the auto industry was down 77% year over year, while car sales have plummeted 60% compared with the same period in 2021. A primary reason is that Russian industries are highly dependent on Western components. Even Putin has acknowledged the problem, admitting last week that, in some sectors, dependence on imported parts is as high as 90%.

To adapt, Russia is turning inward, cutting ties with the rest of the world and moving toward an economic model similar to one adopted by Iran, where political legitimacy rests on providing citizens with the essentials rather than spurring transformative growth, Inozemtsev said.

Russia’s government was better prepared to withstand the sanctions than many in the West expected.

Since the start of the war, the International Monetary Fund has revised its economic outlook for Russia upward twice and is forecasting a 3.5% decline in gross domestic product this year, similar to the government’s projections. This decline, while a major reversal from prewar growth expectations, stands in sharp contrast to the double digits collapse of Venezuela’s economic output after a wave of American sanctions in 2019.

“Sanctions have not destroyed the resilience of the Russian financial system, nor have they impacted macroeconomic stability,” Prime Minister Mikhail Mishustin said last week during a government meeting.

A combination of high oil revenues, large currency reserves and an expert team of economic officials has allowed Putin to soften the blow — much to the frustration of some Western leaders who had hoped the sanctions would have more bite by now.

But the loss of investment, technology and skills caused by the sanctions is likely to echo across generations, depriving many Russians of a chance at a better economic future, experts said.

Those were boom times for Kaluga, an industrial region about 120 miles south of Moscow. The former governor actively courted Western investors, learning English and building a modern airport with several flights a week to Germany. He transformed a regional economy that had been 80% oriented toward the Soviet military industrial complex into one connected with the West. Pharmaceutical companies flocked to the Kaluga region, which has a population of 1 million, and so did auto manufacturers.

Volkswagen hired about 4,200 workers. Volvo and Stellantis, which produced and sold the Peugeot, Citroën, Opel, Jeep and Fiat brands in Russia, also established operations in the region. An ecosystem of suppliers and related industries sprang up to serve them, employing at least 25,000 people, according to Dmitry Trudovoy, chair of the Independent Workers’ Association trade union. Courses in German and other foreign languages at the local university were a pipeline to an office job with the companies.

It seemed as if a new, modern business model was being constructed step by step in the region, a hint of how Russia’s economy might evolve.

By 2020, Volkswagen’s output alone represented about 13% of the Kaluga region’s entire industrial production.

Kaluga’s industrial output fell 30% between February and July this year compared with the same period the year before, according to Rosstat, Russia’s statistics agency, becoming among the regions hit hardest.

Russian state firms and the government have vowed to replace the lost output with local brands. But there have been multiple signs of regression. In June, AvtoVAZ, which makes Russia’s best-known domestic car brand, the Lada, announced that its new cars would meet only 1996 emissions standards and have no passenger-side air bags.

In a symbolic move, an AvtoVAZ affiliate, Kamaz, announced that it would use a Moscow plant vacated by Renault after the invasion to relaunch the production of a Soviet-era car brand, Moskvich, or Muscovite, which had long been an almost comical byword for the deficiencies of communist consumer goods.

Kamaz claims it will produce 50,000 “modern, comfortable, high-quality and safe” cars in the plant next year, including many with electric motors. To aid these efforts, the Russian government plans to channel about $500 million to domestic carmakers.

But modern history offers few examples of successful attempts to replace imported Western technology with local substitutes, said Inozemtsev, the economist. Russian companies lack the know-how and skilled workers to replace Western capital in technology-intensive sectors. Relying on homegrown substitutes will result in “primitivization,” Inozemtsev said.

Production will not disappear, he said, but it will gradually degrade, resulting in lower quality and quantity of products that will progressively reduce the standard of life of Russians.

In Kaluga, the collapse of the auto industry is having wide-ranging collateral effects. The real estate market ground to a halt after the war started, said Kirill Gusev, editor of the online real estate site Kaluga House. It started improving over the summer as people got used to a new normal, but then collapsed after Putin announced a military call-up of hundreds of thousands of men in September.

“After the mobilization, the banks stopped giving out loans because the clients could be called up,” he added.