ECONOMY
‘Defense is Still not as All-Encompassing as it was in the Soviet Union’
March 8, 2024
Oleg Buklemishev
Director of the Economic Policy Research Center at Moscow State UniversityTatiana Rybakova
Journalist and writer
In an interview, economist Oleg Buklemishev talks about the state of the Russian economy, the impact of sanctions and why the current economic model is more stable than the Soviet one.
The original text in Russian was published in Republic and is being republished here with their permission.
Many were surprised by Russia’s 3.6% GDP growth in 2023. But Rosstat released data on the contributors to the growth, and it turns out that half (4.4 percentage points) came from increased inventories. Consumer demand accounted for half that much (2.9 percentage points), while state spending, with its defense orders, contributed only 0.6 percentage points to GDP growth. Meanwhile, net exports took away 4.4 percentage points. Without the increase in inventories, GDP grew only 1.2%. Is my understanding correct that this basically means that inventories are increasing due to a decrease in exports, while the methodology nevertheless counts what is in the warehouse as equal to what is sold and used?
You correctly note two things. The first is that the increase in inventories is quite significant – this has not been observed for the last 10 years or even more. And the second is the shrinking role of net exports, which is quite considerable. But these two things, in my view, are not directly connected with each other. Net exports, I think, fell due to gas, due to wood processing and some other things. But the buildup of inventories is, rather, a microeconomic thing where firms are accumulating excess inventories, it would seem, to carry out future production plans.
So, it is in anticipation of increased demand that they are producing more?
Enterprises have long learned to have more inventories than the norm; they stockpile for years to come, so this is more likely due not to demand, but less supply. Of course, this is a drain on financial resources, but it eliminates risks.
And the second issue is probably stocks associated with the military economy. I would not assume that they are stockpiling, as, strictly speaking, in the statistics all military equipment produced is investment. But it is impossible to conduct large-scale military operations without a lot of other things – stocks of uniforms, gear, ammunition, etc. I do not know how this works; it’s more of a guess than knowledge.
One of the significant drivers of GDP is industrial production growth. Last year it was slightly less than GDP growth. However, if you look at the monthly dynamics, questions arise. In particular, rapid growth was recorded in the first half of 2023, but from May the dynamics have been aboutzero. In terms of sectors, the expected decline happened across the board, but headline growth was driven by manufacturing, which in turn is linked to the production of defense products. Machine building, metallurgy and chemicals grew rapidly (7.5% for 2023). However, growth there (in manufacturing) slowed to 5.4% in December. Again: what is this? Is the defense industry reaching the limit of its capabilities or is there a lot of potential left?
These are the limits to growth not only of the defense industry, but of the economy as a whole. Everyone correctly notes that our economy is now running at its potential or even slightly above that. We have reached our capacity limit. Expanded economic reproduction is possible, but only to the extent that new capacities are introduced, quality and productivity increase, export niches open up, and so on. So, this is natural; there is nothing surprising about it. It is impossible to supercharge capacity, and again, there are not enough people – this is the labor shortage that everyone is talking about now. And the fact that the economy is running with massive budget flows so close to its potential is fine. But it is not possible to go far beyond that – this is also quite natural.
Based on that, should we not expect production growth in the near future, since creating new capacities, even in the defense industry, is not a matter of a day or even a year?
Yes, absolutely right.
Many were surprised by Russia’s 3.6% GDP growth in 2023. But Rosstat released data on the contributors to the growth, and it turns out that half (4.4 percentage points) came from increased inventories. Consumer demand accounted for half that much (2.9 percentage points), while state spending, with its defense orders, contributed only 0.6 percentage points to GDP growth. Meanwhile, net exports took away 4.4 percentage points. Without the increase in inventories, GDP grew only 1.2%. Is my understanding correct that this basically means that inventories are increasing due to a decrease in exports, while the methodology nevertheless counts what is in the warehouse as equal to what is sold and used?
You correctly note two things. The first is that the increase in inventories is quite significant – this has not been observed for the last 10 years or even more. And the second is the shrinking role of net exports, which is quite considerable. But these two things, in my view, are not directly connected with each other. Net exports, I think, fell due to gas, due to wood processing and some other things. But the buildup of inventories is, rather, a microeconomic thing where firms are accumulating excess inventories, it would seem, to carry out future production plans.
So, it is in anticipation of increased demand that they are producing more?
Enterprises have long learned to have more inventories than the norm; they stockpile for years to come, so this is more likely due not to demand, but less supply. Of course, this is a drain on financial resources, but it eliminates risks.
And the second issue is probably stocks associated with the military economy. I would not assume that they are stockpiling, as, strictly speaking, in the statistics all military equipment produced is investment. But it is impossible to conduct large-scale military operations without a lot of other things – stocks of uniforms, gear, ammunition, etc. I do not know how this works; it’s more of a guess than knowledge.
One of the significant drivers of GDP is industrial production growth. Last year it was slightly less than GDP growth. However, if you look at the monthly dynamics, questions arise. In particular, rapid growth was recorded in the first half of 2023, but from May the dynamics have been aboutzero. In terms of sectors, the expected decline happened across the board, but headline growth was driven by manufacturing, which in turn is linked to the production of defense products. Machine building, metallurgy and chemicals grew rapidly (7.5% for 2023). However, growth there (in manufacturing) slowed to 5.4% in December. Again: what is this? Is the defense industry reaching the limit of its capabilities or is there a lot of potential left?
These are the limits to growth not only of the defense industry, but of the economy as a whole. Everyone correctly notes that our economy is now running at its potential or even slightly above that. We have reached our capacity limit. Expanded economic reproduction is possible, but only to the extent that new capacities are introduced, quality and productivity increase, export niches open up, and so on. So, this is natural; there is nothing surprising about it. It is impossible to supercharge capacity, and again, there are not enough people – this is the labor shortage that everyone is talking about now. And the fact that the economy is running with massive budget flows so close to its potential is fine. But it is not possible to go far beyond that – this is also quite natural.
Based on that, should we not expect production growth in the near future, since creating new capacities, even in the defense industry, is not a matter of a day or even a year?
Yes, absolutely right.
“In that defense industry, there is demand from the state; the state, perhaps, would buy more, but there is nowhere and no one to produce it.”
Construction of a residential complex. Naberezhnye Chelny, Tatarstan, 2023. Source: VK
As for market demand, this is also challenging now. The possibilities for exports are much more limited – there are logistical, transport and political restrictions. So, it seems we should not count on an increase in net exports either.
As for consumption – sure, the population consumes, but things are not as rosy as they could be. And here too it is impossible to significantly expand production at the existing facilities. Some imports are being substituted, and this was another source of growth, but there are natural limits to import substitution, in my view. This is technologically and economically clear.
And industrial production growth through import substitution also should not be expected because of capacity limits, right?
Due to capacity limits and limited demand growth. For demand to expand, rapid growth in incomes is needed, as well as confidence in the future so that people do not just receive income – they must be confident that this income will come tomorrow, too.
For example, construction was in fact driven by such expanded demand. But there are limits. Now, there is almost no one left who can afford to purchase new housing at the level of income that they are able to provide for themselves, at the level of interest rates that are out there, and even more so given the wind-down of the preferential mortgage program. So, there is also a (demand) limit.
About incomes. Another source of pride for the Russian authorities is the growth of real household incomes. Numbers show that, indeed, in 2023 real monetary incomes of Russians (minus all obligatory payments) were up 5.4%, after falling by 1.0% in 2022. But if we compare, as people do now, with 2013, the last year of peace before the annexation of Crimea and the imposition of the first sanctions, it turns out that real incomes are two thirds of what they were a decade ago, taking into account inflation and ruble depreciation.
These are also obvious things that we have been talking about for a long time. Real household incomes have not yet rebounded to the level of 10 years ago, of 2013. First of all, this is a reminder that sanctions are not a joke, that since 2014 – it is no coincidence – the Russian economy has been losing the momentum attributable to progress in household incomes.
After all, economic growth is not about inventories, exports or even investment. Growth is only worth something when it translates into an improvement in people’s lives. But in this case, even if we recorded growth in terms of GDP or real incomes, we basically are back at the same point 10 years later. This is what can already be called a lost decade. If we talk about incomes in dollar terms, then perhaps we will never get back to the previous point, to 2013.
Why does the population not feel this? Surveys usually show that consumer confidence is not as high as that of business, but at the same time it is not very low. No matter who you ask, everyone assures you that there is money, and a lot of it. It’s just that they themselves do not have it– but that’s just how things shook out, for now... Why is this so?
This is a rather interesting phenomenon: both firms and the population now look more optimistic than specialists in our “dismal science” would expect them to be. It is about how things are perceived. I think that in Russia this is largely due to income growth.
As for consumption – sure, the population consumes, but things are not as rosy as they could be. And here too it is impossible to significantly expand production at the existing facilities. Some imports are being substituted, and this was another source of growth, but there are natural limits to import substitution, in my view. This is technologically and economically clear.
And industrial production growth through import substitution also should not be expected because of capacity limits, right?
Due to capacity limits and limited demand growth. For demand to expand, rapid growth in incomes is needed, as well as confidence in the future so that people do not just receive income – they must be confident that this income will come tomorrow, too.
For example, construction was in fact driven by such expanded demand. But there are limits. Now, there is almost no one left who can afford to purchase new housing at the level of income that they are able to provide for themselves, at the level of interest rates that are out there, and even more so given the wind-down of the preferential mortgage program. So, there is also a (demand) limit.
About incomes. Another source of pride for the Russian authorities is the growth of real household incomes. Numbers show that, indeed, in 2023 real monetary incomes of Russians (minus all obligatory payments) were up 5.4%, after falling by 1.0% in 2022. But if we compare, as people do now, with 2013, the last year of peace before the annexation of Crimea and the imposition of the first sanctions, it turns out that real incomes are two thirds of what they were a decade ago, taking into account inflation and ruble depreciation.
These are also obvious things that we have been talking about for a long time. Real household incomes have not yet rebounded to the level of 10 years ago, of 2013. First of all, this is a reminder that sanctions are not a joke, that since 2014 – it is no coincidence – the Russian economy has been losing the momentum attributable to progress in household incomes.
After all, economic growth is not about inventories, exports or even investment. Growth is only worth something when it translates into an improvement in people’s lives. But in this case, even if we recorded growth in terms of GDP or real incomes, we basically are back at the same point 10 years later. This is what can already be called a lost decade. If we talk about incomes in dollar terms, then perhaps we will never get back to the previous point, to 2013.
Why does the population not feel this? Surveys usually show that consumer confidence is not as high as that of business, but at the same time it is not very low. No matter who you ask, everyone assures you that there is money, and a lot of it. It’s just that they themselves do not have it– but that’s just how things shook out, for now... Why is this so?
This is a rather interesting phenomenon: both firms and the population now look more optimistic than specialists in our “dismal science” would expect them to be. It is about how things are perceived. I think that in Russia this is largely due to income growth.
“Recently, incomes have risen across a larger swath of the population – going up disproportionately for the poor and below-average segments.”
Barnaultransmash, a diesel engine plant. Barnaul, Altai Krai. Source: VK
In sociological research, you get optimism, but simply because the money is being distributed differently. But this does not show up in economic development since everyone is just a little bit better off. Every poor person just a little bit – this means no improvement in the overall economic situation. Do not forget that there are also many losers in the current situation – in particular, workers at firms with foreign investment that have closed.
People are increasingly saying that the Russian economy is going down the Soviet path, where the defense industry grew, but the consumer sector withered. How appropriate is this comparison? At the same time, the USSR was quite active in foreign trade and exported a lot –gas and oil, first of all. Export earnings made it possible to partially satisfy consumer demand. In Russia, judging by data from the customs service, export revenues were down 30% in 2023. Judging by Rosstat data, the physical volumes of the main export goods also decreased: commodity export volumes fell 1.3% in 2023, versus an increase of 1.5% in 2022. In other words, the consumer economy is shrinking, with exports falling both in physical and monetary terms, but the output of the defense industry is growing at an unprecedented pace. Does it stand to reason that at this pace the Russian economy will collapse much faster than the Soviet one?
First of all, the Soviet economy was structured differently: it was not guided by demand, it was guided by a plan. And as part of that plan a fairly large component was defense and security. It is difficult to compare the Soviet economy with others, but if we look at the relative indicators of that period, then in terms of the share of both budget expenditures and gross income, until its end the Soviet economy spent approximately twice as much on the defense sector as the leading countries of NATO. Accordingly, and this is the general view, military production played a much larger role in the Soviet Union than it does now.
The country was much more militarized and, under the Soviet system of goods distribution, income distribution, in the absence of private property, it could redistribute money much more freely.
It’s not even about exports. From the standpoint of exports, the Soviet Union looks terribly antiquated by today’s standards. We have already broken all the Soviet records – both oil and other ones. And back then efficiency was quite inferior, in my view, compared to what we have with the market economy. Take agricultural production – a chronic grain importer turned into a major exporter in just a decade.
People are increasingly saying that the Russian economy is going down the Soviet path, where the defense industry grew, but the consumer sector withered. How appropriate is this comparison? At the same time, the USSR was quite active in foreign trade and exported a lot –gas and oil, first of all. Export earnings made it possible to partially satisfy consumer demand. In Russia, judging by data from the customs service, export revenues were down 30% in 2023. Judging by Rosstat data, the physical volumes of the main export goods also decreased: commodity export volumes fell 1.3% in 2023, versus an increase of 1.5% in 2022. In other words, the consumer economy is shrinking, with exports falling both in physical and monetary terms, but the output of the defense industry is growing at an unprecedented pace. Does it stand to reason that at this pace the Russian economy will collapse much faster than the Soviet one?
First of all, the Soviet economy was structured differently: it was not guided by demand, it was guided by a plan. And as part of that plan a fairly large component was defense and security. It is difficult to compare the Soviet economy with others, but if we look at the relative indicators of that period, then in terms of the share of both budget expenditures and gross income, until its end the Soviet economy spent approximately twice as much on the defense sector as the leading countries of NATO. Accordingly, and this is the general view, military production played a much larger role in the Soviet Union than it does now.
The country was much more militarized and, under the Soviet system of goods distribution, income distribution, in the absence of private property, it could redistribute money much more freely.
It’s not even about exports. From the standpoint of exports, the Soviet Union looks terribly antiquated by today’s standards. We have already broken all the Soviet records – both oil and other ones. And back then efficiency was quite inferior, in my view, compared to what we have with the market economy. Take agricultural production – a chronic grain importer turned into a major exporter in just a decade.
“We are following the Soviet path, but we are going down it under a completely different system, where redistribution is difficult.”
Where you cannot just take, centralize and move money where you want it. This can only be done in a limited manner through a fairly developed tax system that is based on capitalist principles. To mobilize revenues in this system, the political and economic lift required is much more than in the Soviet system.
Can we say that the current system – even with the expanding defense sector and the shrinking consumer sector, with the simultaneous fall in exports – is nevertheless more stable than the Soviet one?
I think so. And the current system is invisibly supported by the market basis of the economy, where supply and demand signals are at work and price signals are at work. All this is going on in the system. And that’s exactly why it’s more flexible and more adaptable. Plus, defense is still not as all-encompassing as it was in the Soviet Union.
Does this mean that we will never get back to the Soviet Union?
Well, we can, but there’s still a long way to go.
Can we say that the current system – even with the expanding defense sector and the shrinking consumer sector, with the simultaneous fall in exports – is nevertheless more stable than the Soviet one?
I think so. And the current system is invisibly supported by the market basis of the economy, where supply and demand signals are at work and price signals are at work. All this is going on in the system. And that’s exactly why it’s more flexible and more adaptable. Plus, defense is still not as all-encompassing as it was in the Soviet Union.
Does this mean that we will never get back to the Soviet Union?
Well, we can, but there’s still a long way to go.
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