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 7 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.
Crimea referendum and independence
Crimea referendum and independence
1/14 Crimea Referendum
A man shows his shirt with the Russian emblem as he celebrates the results of the Crimean referendum at the Lenin Square in Simferopol
2/14 Crimea Referendum
An elderly retired Soviet Navy officer and his wife take a walk in Sevastopol the morning after the referendum
3/14 Crimea Referendum
A man plays accordion as people dance during celebrations in Sevastopol
4/14 Crimea Referendum
People wave Russian flags as fireworks explode in the sky over Sevastopol following the announcement of the result of the referendum
5/14 Crimea Referendum
A member of a Ukrainian "Maidan" self-defense battalion takes part in training to qualify for service in the newly-created National Guard.
6/14 Crimea Referendum
Pro-Russian protesters hold a Russian, Crimean and Soviet flags during their rally at Lenin Square in Simferopol, Ukraine
7/14 Crimea Referendum
A member of the Crimean election commission waits for voters at the polling station in Belogorsk near Simferopol, Crimea, Ukraine
8/14 Crimea Referendum
Polling stations opened in Crimea for a referendum about whether the Ukrainian Black Sea region should join Russia. The vote has been widely condemned by Western governments, who call it illegal and have announced sanctions against Russia if it goes ahead. Thousands of unmarked forces, believed to be Russian, have appeared in Crimea after local Moscow-backed authorities asked Russia for protection against 'extremists' in the new Ukrainian leadership
9/14 Crimea Referendum
A lettering on the facade of the Council of Ministers building reads 'Spring in Crimea' in Simferopol, Crimea, Ukraine
10/14 Crimea Referendum
People wave Crimean flags at Lenin square in Simferopol, Crimea, Ukraine
11/14 Crimea Referendum
A poster in Crimea presents a stark choice - Nazism, or Russia - to voters ahead of the referendum
12/14 Crimea Referendum
Protesters against Ukraine’s referendum gather in Simferopol
13/14 Crimea Referendum
Action stations: Preparations for today’s referendum in Simferopol, where Crimea will vote to become part of Russia
14/14 Crimea Referendum
Cossacks guard the regional parliament building in Simferopol during the Crimean referendum
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.
An upswing everywhere you look
There is such a thing as the economic cycle. That is something to remember today when we get our next Budget. The forecasts for the UK economy will be much better but so too are the forecasts – and the performance – for the entire developed world. In the past few days there have been a string of news stories from different parts of the developed world that all support the same message: that there is a strong cyclical upswing taking place.
Take travel and tourism, on some measures the largest industry of all. The World Travel and Tourism Council has just reported that it grew by 3 per cent last year and accounts for 9.5 per cent of the world economy. It expects even faster growth in 2014. Take European car sales. The February figures show that these are up 7.6 per cent year-on-year, with exceptionally strong growth in Portugal, Ireland and Spain. Take US share prices. Not only have they started to downplay any damage to the US from the Russia commotions but yesterday the share price of Microsoft hit the highest level since 2000.
The point here is simply that the world economy is self-correcting. No one should downplay the importance of sensible economic policy, nor of emergency action when things go wrong. But after several very difficult years people are feeling confident enough to spend more on luxuries such as foreign travel, buying cars even in countries that have had a dreadful recession, or buying shares in a huge software enterprise.
Travel, cars and software are all in different ways bellwether industries. They remind us that if key industries in the developed world are doing better, then they will pull up the laggards too. Somewhere out there lies another recession, but meanwhile the cycle is heading up.