Our sanctions will not cripple Russia. It is doing a lot of the dirty work itself

Putin's desire to restore past glories of the Soviet Union will lead to economic failure

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This is not a new Cold War. These new upgraded, “phase three” economic sanctions will not suddenly bring Russia to its knees.

But what they will do, coupled with Russia’s response to them, is make it impossible for Russia to escape the middle income trap – stop it from turning itself into a fully developed economy, with all the wealth and other benefits that western Europe enjoys, and its former satellites in eastern Europe are now acquiring.

That would be the least-bad outcome for Russia. It is massively dependent on energy prices and if they were to fall or even fail to rise, the country would slip backwards to the economic failure of the last days of the Soviet era – a failure that brought the old regime to its knees.

If that seems overly dramatic, remember why the Soviet empire collapsed. In popular mythology it was losing the military competition with the US. But behind that was the inability of its closed economic system to generate the wealth to persuade its citizens to keep it. It was a failure of Comecon, the economic trading bloc founded in 1949 to bind its satellite countries to the Soviet Union, as much as the failure of the Soviet Union itself. If people in eastern Europe had been as rich as those in western Europe, the empire might well have survived.

The reasons for the failure of the Soviet Union’s economic system are directly relevant to the sanctions being imposed on Russia now. For a while, through the 1950s and 1960s, the Soviet empire managed more or less to keep up, even spurting ahead in some areas such as space exploration.

But as Western economies became more and more sophisticated, the gap grew. We all knew that a Lada was worse than a VW, and that a command economy could not satisfy human needs and desires as effectively as a market one. But it was the growing complexity of Western economies, speeded up by the widespread application of computers, that had by the 1980s made the gap unbridgeable.

Now consider the new sanctions. They are targeting three main areas: finance, energy technology and military equipment. Leave the last aside, because that is really outside the normal economic field – though it is curious that the Russians chose to go to France to build its helicopter carriers, for you would imagine they could do that for themselves.

 

The key financial sanctions will be those against Russian banks, in effect making it impossible for them to sell securities to the world market. This does not quite close Russia to global capital, though right now is not a great time for any Russian entity to try to persuade investors that they should stick money into the country. Russian stocks are currently very cheap by world standards, for the most obvious of reasons. What the sanctions will do is make attracting foreign capital even harder, and while you can run a country with only limited access to global markets, you impose a big penalty on yourself if you try to do so. Look at Argentina.

Russia needs both foreign expertise as well as foreign capital to develop its energy resources, which is why the second element of the sanctions matters. The gas industry is excluded because Europe gets about a third of its gas from Russia – we would be cutting our nose off to spite our face. But by focusing on oil, the sanctions will, at the margin, make it more difficult for Russia to develop its supplies. Russian oil is difficult to extract and Western oil companies are much better than Russian ones at doing so. (Why is BP a shareholder in the state-controlled oil giant, Rosneft? Because it has technologies that Russia lacks.)

To be clear, our sanctions will not push Russia back to its old command and control economy. We cannot do that, nor should we try. But in the short-term, Russia is hobbling itself by becoming a most unattractive place in which to invest, and it desperately needs foreign know-how to make the best of its hugely important energy resources.

The instincts of Russian leadership that want to restore past glories of the Soviet Union are the same instincts that will restore elements of its past economic failure. Of course Russia, unlike China, made a mess of its transition from command economy to market one – largely, the Chinese say, because Russia hired a lot of American economic experts with no experience of the world outside the US. But the task facing the Russian leadership now is to nudge the country’s economy towards the European market model, not to cut it off from it.

That goes back to the great economic issue facing Russia. It is easy to make a country poor; much harder to make it rich. It is easy to make a few people rich, much harder to spread that wealth through the community.

Russia sits on huge mineral and energy resources. Last year it produced 13 per cent of the world’s oil and 18 per cent of its gas, which together provide two-thirds of its export earnings. But it is terrifying, or at least it should be, for such a large country to be so dependent on a narrow range of exports.

These also pay for the government, which needs an oil price of around $100 a barrel to finance itself, and they pay for the multitude of imported goods that Russia needs. Until Russia develops other competitive exports of goods and services, it is stuck, and the Russian people as a whole will not be able to experience the sort of lifestyles that their education, culture, diligence and sheer hard work would earn them in any normal Western-style market economy.

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