I am not an economic determinist, at least in the sense that I don’t assume that people are motivated by lucre alone. I do not believe, for example, that economic factors, deeply rooted or otherwise, are always the “real” cause of war. And economic factors only sometimes account for the outcome of wars, as Americans were reminded in Vietnam.

I do believe, however, that what the Soviets used to call the “correlation of forces” – that is, the dynamics of the global balance of power – is driven primarily by economic factors. Size matters, geography matters, culture matters, institutions matter, but economic performance matters most (even if economic performance is partially or largely a product of any or all of the former).

That has been true in past centuries, and it will be true in this century. If the advanced liberal democracies can get their economies growing again at respectable rates, if China’s growth continues to slow, and if “emerging” economies continue to grow faster than developed ones, the world will look one way in twenty years. If not, it will look very differently.

What this means is that Russia’s geopolitical weight ten or twenty years hence is going to be driven mostly by relative economic performance. In particular, it will be a function of how Russian growth compares to growth in the three economies that matter most to it geopolitically – the U.S. economy, the EU economy, and the Chinese economy.

Growth prospects for Russia’s geopolitical competitors

The good news for the Kremlin, in its zero-sum world, is that estimates for the long-term (trend) rate of growth for its three major competitors have been declining.

Of particular importance is the fact that all large market-capitalist economies are in trouble — the US, Germany, Britain, France, Italy, and Japan are all struggling to one degree or another.

Doubtless most comforting to the Kremlin is the possibility that trend growth for the United States has declined from some 3.3% per year (the average from 1947 to 2014 was 3.27%) to 2.5 or even 2.0%. Larry Summers, among others, has suggested that the US is facing a long period of “secular stagnation” (see, for example, his interview in The New Republic, July 23, 2014).

Estimates of trend growth for the EU, and especially for the Euro zone countries, are lower yet, even assuming the EU manages to overcome its governance problems. Despite optimism earlier this year that an EU economic recovery was underway, it is now clear the Euro crisis is far from over and that there is a considerable risk of another recession and, even more worryingly, of deflation in Europe. But even if the Euro survives and growth in the EU picks up, it is unlikely that the EU economy as a whole is going to grow robustly (say, 3% per year or more) in the coming years or sustain that rate of growth for very long.

Meanwhile, the Kremlin can reasonably hope that the growing popularity of left-wing and right-wing anti-system and anti-EU parties in Europe will weaken the EU politically and perhaps even destroy it. Indeed the prospect of European disunion was why Russia’s state-controlled media was so excited about the prospect that Scotland would vote for independence last week. Scottish independence would have increased the likelihood that rump Britain would vote to withdraw from the EU in 2017, when David Cameron has promised a referendum should he be reelected prime minister.

As for China, there are widespread expectations that its growth rate will continue to decline as GDP per capita increases and it rises in the ranks of what the World Bank calls “middle income” and eventually “upper middle income” countries. This year the Chinese government’s growth target is 7.5%, some 2% lower than the average during the years leading up to the 2008 financial crisis. That 7.5% target, however, does not look like it is going to be met. Beyond that, there are concerns that growth is already overstated and that structural problems are going to slow the economy further to perhaps 5% over the next decade. There are also widespread suspicions that Chinese statistics are unreliable and exaggerate the size of the Chinese economy by as much as a third.

Russia’s geoeconomic weight today

Table 1 (at the bottom of the post – WordPress doesn’t seem to like Excel tables) below gives 2013 GDP figures for (1) Russia, (2) the US, (3) the EU, (4) the US and EU combined (roughly the “small West” that is, one that does not include non-EU countries in Europe, Canada, Australia, and New Zealand), (5) China, and (6) the world. As shown in the first column, the Russian economy makes up 2.8% of world output in nominal terms, compared to 22.5% for the United States, 22.8% for the European Union, and 12.6% for China. The Russian economy is thus roughly one-tenth the size of the US economy; one-tenth the size of the EU economy; one-twentieth the size of the US and EU combined; and one fifth the size of China’s economy.

Table 2 projects Russia’s geoeconomic weight in 2023 and 2033 making some optimistic assumptions (optimistic from Russia’s perspective, that is) about long-term growth. It assumes an average annual growth rate for Russia of 5% over the entire twenty-year period, and below consensus rates for the United States (1.5%), the EU (1%), and China (5%). In this “optimistic” scenario, the Russian share of the global economy increases from roughly 2.8% today to 3.4% in 2033. Its size relative to the US economy increases from 12.6% to 24.7% by 2033; its size relative to the EU and US economies combined is 12.9% in 2033; and its size relative to China is 22.6% (not shown).

Table 3 is a rough “baseline scenario” that offers what I take to be consensus estimates for trend growth for the same four economies: 2.5% for Russia, 2.2% for the US, 2.0% for the EU, and 5.5% for China. Under this scenario, Russia’s share of global output falls from 2.8% today to 2.1% in 2033, and its relative size changes little with respect to the US and EU, and it declines relative to China.

Finally, Table 4 is a “pessimistic scenario” for the Kremlin. It assumes a growth rate for Russia of 1%; approximate historical rates for the US and EU; and 8% for China. Here Russia’s share of the global economy falls to 1.6% in 2033; its economy is only 8.2% the size of the US economy, 4.2% of the combined US/EU economy, and 6% of the Chinese economy.

Average growth rates across the globe over the next twenty years are sure to produce some major surprises. But the point is that it would take an extraordinary combination of factors for Russia to make up, for example, 10% of world output by 2033, which is less than half of what the US contributes today. Even with very optimistic (for Russia) assumptions about growth rates, the Russian economy is going to remain much smaller than the US’s, the EU’s, and China’s for the foreseeable future. Under a pessimistic scenario, it will fall farther behind its geopolitical competitors, contributing roughly the same to world output in 2033 that South Korea contributes today, despite the fact that South Korea today has one-third the population.

Finally, it is important to appreciate that Russia is still much less wealthy per capita than either the US or EU (although it is roughly two times wealthier per capita than China in adjusted ppp dollars). Russia is not, in other words, a vanguard economy – it does not offer a model of high-value added, technologically sophisticated, productivity-driven growth. The rapid growth that it achieved after its financial meltdown in 1998 was in large measure the result of energy exports and the high price of oil and gas on international markets. As a result, few countries will look to Russia today as a model. These characteristics – the relatively small size of the Russian economy, its extraction oriented growth model, and its inability to inspire others – are not going to change for years, if ever.

Why Russia punches above its geoeconomic weight

This is not to suggest that Russia is economically unimportant. It is the eighth (or ninth, depending on what data you use) largest economy in the world in nominal terms, with very large foreign currency reserves. It is also a superpower in energy production and exports. Nevertheless, geopolitically Russia punches well above its economic weight. Its economy is roughly the size of Italy’s or Brazil’s, for example, but it is much more politically assertive and influential on the international stage.

Why? Part of the reason is size and location. Russia is territorially huge (although it is only ninth globally in terms of population), and it is situated in the heart of Eurasia. Another reason is that Russia demanded, and the international community agreed, that it would be the legal heir to the Soviet Union. This has had many consequences, many of which have been unfortunate for Russia, but it did mean that Russia inherited the Soviet Union’s seat as a permanent member of the UN Security Council, with its attendant right to veto UNSC resolutions, including those authorizing the use of force. It also helps account for why Russia inherited the entirety of the USSR’s nuclear arsenal and most of the USSR’s conventional military assets.

Also contributing to Russia’s geopolitical weight are its natural gas exports. Natural gas, unlike oil, can be delivered in large volumes only through expensive pipelines under long contracts. As a result, it is much more difficult for buyers to find alternatives if a supplier cuts off gas deliveries than it is to find alternative oil suppliers. Oil, unlike gas, can be delivered at competitive prices by tanker, rail, or truck. (Lower gas prices may make liquefied natural gas – LNG – more competitive, but insufficient LNG infrastructure is going to prevent it from becoming a significant part of global or European consumption for decades, even assuming natural gas prices continue to fall.) And Russia has used, and will continue to use, natural gas exports as an instrument of pressure on consuming countries.

More important than natural gas exports, however, is Moscow’s ability to project hard power along its borders, a capacity made possible in large part by revenue from oil exports. Natural gas gives Moscow political leverage over consuming countries, but Russia needs to sell that gas, which means it can’t cut supplies for too long or to too many customers. Nor does it want to encourage consumers to find alternative suppliers or switch to more reliable types of fuel. What really counts for Russia’s disproportionate geopolitical weight, then, is military power made possible by oil earnings.

Perhaps most importantly, unlike in Italy, Brazil, or other countries in its economic weight class, the preponderance of the Russian elite and Russian people believe it is rightful, and natural, that Russia be a “Great Power,” an equal to any other Great Power, first and foremost the United States. And as a Great Power it is rightful and proper that it be afforded, or if necessary that it carve out, a sphere of influence in its geopolitical neighborhood.

Russia’s short-term growth prospects

In the long run, what is going to determine whether these Great Power ambitions are realized is Russian economic performance. Declining, and lagging, economic output was what brought down the Soviet Union. It was also what accounted for Russian weakness during its “Time of Troubles” in the 1990s. And it was what allowed Russia to return to the world stage as a “great power” in the 2000s.

What, then, are Russia’s growth prospects?

Until last year, Russian authorities had reason to hope that trend growth in Russia might be as high as five or even 6% for the next decade and perhaps longer. The economy had grown faster than in the decade prior to the 2008 financial crisis, and while Russia took a big hit in 2009, the economy began growing again in 2010 (4.5%) and performed reasonably well in 2011 (4.3%) and 2012 (3.4%). This post-crisis growth came despite a soft global economy and, in particular, weakness in the EU, Russia’s top trading partner.

In 2013, however, the economy seemed to hit a wall – well before the Ukrainian crisis broke out at the end of the year. At the beginning of 2013, most forecasters were expecting the economy to grow at 4% or higher for the year. Actual performance came in at 1.3%. By the middle of the year, Russian and Western economists were debating the possibility that the country was suffering from a long-term “growth crisis.”

The economy has continued to disappoint this year. The World Bank has lowered its GDP growth estimate to 0.5%, while the IMF forecast is only 0.2%. Both of these forecasts were issued before the latest round of Western sanctions. Inflation, which was above central bank targets even before Moscow’s recent ban on food imports, is forecast to be some 8% for the year. Private consumption is falling as consumers come under pressure from a falling ruble, which is now at its lowest level ever against the dollar. Capital flight accelerated dramatically in 2013 and will be worse this year – at least $100 billion and perhaps twice that. The Russian Central Bank, in an effort to keep a lid on inflation, to moderate capital flight, and to keep the ruble from declining further, raised interest rates from 6% to 8% earlier in the year. The Micex index is down some 27% from its peak in 2007, and Russian stock prices are trading at around half the price/earning ratio of equities in other emerging markets. Increasingly severe sanctions may mean that the economy is already in recession, and the economy will almost certainly deteriorate further in the coming months in the face of growing trade barriers, capital flight, and declining oil prices. The Finance Minister has announced that it will raid the Russian Pension Fund in 2015 to help companies hurt by Western sanctions. And Alexander Kudrin, Putin’s former finance minister, has warned that the economy may shrink by 5% if Western sanctions on Russia’s financial sector are extended to include access to the SWIFT clearing system by Russian banks.

Russia is fortunate, however, in having very large foreign currency reserves, thanks to prudent macro economic policies during the growth years, which serves as a cushion against external shocks. Its Reserve Fund, which is intended to protect the economy against short-term shocks, is valued at around 3% of GDP. A lower ruble also helps the government budget because oil exports are priced in dollars (even if it hurts consumers who have to pay more for imports). The government planned to increase the Fund to 7% of GDP by 2019, but that is now unlikely in the face of slowing growth.

Nevertheless, what must really worry the Kremlin is the possibility that oil prices fall to the point that government spending comes under real pressure. Energy exports account for about half of federal tax revenue. Natural gas earnings are relatively stable because of long-term contracts, but oil prices are not, which makes federal revenues very sensitive to the price of oil in international markets – a $1 fall in the price per barrel reduces tax revenues by some $1.4 billion. The price of Urals crude is now under $100 per barrel ($96.8 on September 21) from a 52-week high of $116 per barrel. The price that Russian companies receive for oil exports over the course of this year is likely to average over $104, the figure used by the Finance Ministry in its budget forecasts. At an average price of $104, the Finance Ministry forecasts a 2014 budget surplus of 0.4%. Oil prices are also still above the $93 per barrel price the Finance Ministry uses to cap spending – if it falls below $93, spending cuts are supposed to kick in. But a significant fall in oil prices would be a major problem for the Russian economy. Analysts estimate that at $85 per barrel, the federal deficit would rise to 3% of GDP. Russia could presumably borrow to fund the deficit, but it is unclear at what rates. Were it to try to cover it using the Reserve Fund, the fund would be exhausted in a year at that price per barrel. And of course budget pressures would be even worse were oil prices to go even lower.

Fortunately for the Kremlin, it is unlikely that oil will fall very far very quickly. Futures markets are predicting a price of a little over $91 a year from now and a longer-term decline to around $88 by the end of 2018. But it is of course possible that prices will be lower than expected. The Kremlin must be particularly worried about the economic policy of one particular country – Saudi Arabia. Many analysts expect OPEC, which is to say Saudi Arabia, to keep oil prices from falling further, which would be very good news for Moscow. But Riyadh may choose to punish the Kremlin for its support of the Assad regime in Syria by allowing a sharp decline in oil prices, which would hit the Russian economy hard. Oil plummeted from a high of $147 in 2008 to less than $40 per barrel after the financial crisis, which helps explain why the Russian economy shrank by almost 8% in 2009. The Russian Central Bank was also forced to use some $200 billion of the Reserve Fund  in a matter of months to prop up the ruble that year. Over the longer term, the Kremlin also faces a serious supply problem. The International Energy Agency has estimated Russia needs $750 billion of investment over the coming two decades to keep its oil and gas production from falling. That was very unlikely even before US and EU sanctions targeting Russia’s energy industries went into effect.

At the least, then, the Russian economy is almost certainly going to struggle over the next several years, and there is a risk that it may go into free fall. This will almost certainly make for political problems for Putin. His approval ratings are now extremely high, and they would very likely return to their still-high baseline of around 60% even if the economy wasn’t in trouble. But several years of cuts in government services, higher inflation, and lower consumption are going to increase domestic opposition to the current leadership. (What would almost certainly make for severe political problems for Putin would be a spike in unemployment, but that seems unlikely.) The Russian public may have a high tolerance for economic pain, considerably higher than Western publics, but that tolerance is not limitless. As a result, the Kremlin must worry, with good reason, that an economic crisis, combined with public perceptions of waste and corruption, and opposition to Russian involvement in a war in Ukraine that pits Russians against fellow Slavs, may eventually threaten the regime, or at the least will force the Kremlin to end even a pretense of democracy.

Long-term growth, military spending, and Russia’s geopolitical ambitions

For Russia as a whole, and for Putin’s broader geopolitical ambitions, the problem is not so much the immediate affects of Russia’s economic travails as the country’s long-term growth potential. Clifford Gaddy and Barry Ickes argue in a recent issue of The Milken Institute Review (“Reality Check,” summer 2014) that Russia’s growth potential is likely below 3% and perhaps lower than 2%. These estimates do not account for the long-term effects of Western sanctions, a significant decline in oil prices, or the increasingly counterproductive economic policies being adopted in Moscow. They conclude:

Russia does face a growth crisis. This is just dawning on people. It should have been recognized earlier. It wasn’t, because several years of growth produced by the oil-price-induced transfer of wealth to Russia from the outside were mistaken for “normal” growth.

They also argue that Putin “lacks a plan to cure the ills of the economy. He apparently will maintain business as usual, based on mega-projects and tens of trillions of rubles for defense industry modernization and industrialization of Russia’s coldest and most remote regions in the East.”

Indeed, one way to think about the effect of economic headwinds for Russia’s geopolitical ambitions is to consider how declining economic performance is going to force the regime to choose between its ambitious plans for military modernization and spending on social protections and infrastructure. Russian military expenditures have increased by some 50% over the past five years and in 2013 were around 4.1% of GDP (as estimated by the Stockholm International Peace Research Institute). While total Russian military spending is still much less than in the United States or EU, as a percentage of GDP, Russia is spending more than twice the average for NATO members other than the United States. For the first time in years, it spent more in 2013 as a percentage of GDP (4.1%) than the United States (3.8%). Nevertheless, it plans to increase military spending significantly in the coming years. According to an article in Izvestia in July, government sources are reporting that military spending will increase from 17.5% of federal spending today to 21% in 2017. Over the longer term, Moscow plans to replace 70% of Russia’s military equipment by 2020 at a cost of more than $700 billion.

All of this is very expensive, and it is very unlikely the Kremlin’s military spending plans were going to be realized even before the Ukraine crisis. The slowing economy was already putting those plans at risk, particularly given Putin’s presidential campaign promises to increase social spending. The Ukraine crisis has only made matters worse. The annexation of Crimea and Russia’s involvement in eastern Ukraine have cost, and will continue to cost, Moscow a great deal. The government is also going to have to fund the replacement of military equipment and parts that Ukraine’s important and sophisticated military industries exported to Russia.

And there are other costs bearing down on the Russian government as well. Western sanctions are going to make developing Russia’s oil and gas fields more costly. Rerouting Russian pipelines and building the infrastructure to increase trade with China is going to be costly. Replacing food products and other consumer products formerly imported from Western countries is going to be costly. Making the economy less open and more “Russian” is going to be costly. And almost everything is going to be made more costly by restrictions on Western technology.

Also costly are Russia’s “mega-projects.” Indeed, in many respects the Sochi Olympics is symptomatic of what ails the Russian economy. Whatever the actual figures were for how much money went into the 2014 Winter Olympics (the usual guesstimate is $51 billion), it is clear that they were extremely expensive and cost much more than any other Olympics in history. In the short term the Olympics went extremely well. There were no terrorist incidents, there was plenty of snow, the sporting events were efficiently organized, the opening and closing ceremonies were spectacular, and Russia comfortably won the medal count, far exceeding expectations. But Putin’s intent was to use the Games to turn Sochi into a world class, year-round tourist resort, one that over the long-run would produce a decent return on public and private investment. That seems extremely unlikely at this point. The city seems to have been mostly empty this summer despite the dramatic decline in tourism in nearby Crimea (see, for example, the photo essay at http://macos.livejournal.com/939210.html). Low private investment, and poorly invested public monies, is a hallmark of an economy suffering from classic Dutch Disease.

At any rate, a slowing economy, or a shrinking one, is eventually going to put pressure, possibly acute pressure, on the government to cut federal spending. If so, it is hard to believe that the Russian public will support a dramatic increase in military spending in the face of cutbacks in spending on pensions, education, healthcare, and other social programs.

Conclusion

Readers of this blog will know that I believe that the Ukraine crisis has been a strategic disaster for Russia. The Kremlin can take comfort in the economic and political woes of the United States and its European allies, but the fact is that Russia is going to be treated for the foreseeable future as an adversary by an alliance of states that is collectively much larger and more powerful. Moreover, Russia’s immediate neighbors are even more wary of it than before, and Russia does not have a single genuine ally – not even Belarus – that it can count on for political support in the coming years. Above all, the Kremlin’s policies have turned the great bulk of the Ukrainian population against Russia for the foreseeable future.

This is not a good outcome for a country that contributes less than 3% to world GDP, is very vulnerable to world oil prices, and has poor growth prospects. The Kremlin – and most of Russia’s political elite – seem to think that Russia’s interests are best served by an international system driven by power politics, economic mercantilism, and military competition. Nothing could be further from the truth. As an economic middleweight that is highly dependent on commodity exports, Russia’s interests would be much better served by a liberal international order that minimizes the risks of military conflict, reduces the burden of military expenditures, and allows it to use its resource endowments to gradually modernize its economy. Russia cannot afford a prolonged geopolitical confrontation with the West any more than the Soviet Union could before it.

Table 1: Russia geoeconomic weight 2013
	Russia	% World	US	% World	EU	% World	US+EU	% World	China	% World	World
GDP nominal (trillion)	$2.11	2.8%	$16.72	22.5%	$16.95	22.8%	$33.67	45.3%	$9.33	12.6%	$74.31
GDP nominal per capita	$14,838		$52,430		$33,144		$40,552		$9,877		$10,356
GDP PPP (trillion)	$2.55	2.9%	$16.72	19.2%	$15.85	18.2%	$32.57	37.3%	$13.39	15.3%	$87.25
GDP per capita PPP	$18,100		$52,800		$34,500		$39,227		$9,800		$13,100
Population (million)	142.5	2.0%	318.9	4.4%	511.4	7.1%	830.3	11.6%	1355.7	18.9%	7174.6

Table 2: (Optimistic scenario): Average annual growth for Russia 5%, US 1.5%, EU 1%, China 5%, World 4%
	2023					2033
	GDP (trillion)	Percent of World	Percent of US	Percent of EU+US		GDP (trillion)	Percent of World	Percent of US	Percent of EU+US
Russian Federation	$3.4	3.1%	17.6%	9.4%		$5.6	3.4%	24.7%	12.9%
United States	$19.4	17.7%	100.0%	44.0%		$22.5	13.8%	100.0%	52.2%
European Union	$17.1	15.5%	88.1%	38.8%		$20.7	12.7%	91.7%	47.8%
US plus EU	$36.5	33.2%	188.1%	82.8%		$43.2	26.5%	191.7%	100.0%
China	$15.2	13.8%	78.3%	34.5%		$24.8	15.2%	109.9%	57.3%
World	$110.0	100.0%	566.6%	249.6%		$162.8	100.0%	722.9%	377.1%

Table 3: (Baseline scenario): Average annual growth for Russia 2.5%, US 2.2%, EU 2.0%, China 5.5%, World 4%
	2023					2033
	GDP (trillion)	Percent of World	Percent of US	Percent of EU+US		GDP (trillion)	Percent of World	Percent of US	Percent of EU+US
Russian Federation	$2.7	2.4%	12.9%	6.6%		$3.4	2.1%	13.1%	6.7%
United States	$20.8	18.9%	100.0%	50.2%		$25.9	15.9%	100.0%	50.7%
European Union	$20.6	18.8%	99.1%	49.8%		$25.2	15.5%	97.3%	49.3%
US plus EU	$41.5	37.7%	199.1%	100.0%		$51.1	31.4%	197.3%	100.0%
China	$15.9	14.5%	76.5%	38.4%		$27.2	16.7%	105.0%	53.2%
World	$110.0	100.0%	527.9%	265.2%		$162.8	100.0%	628.6%	318.6%

Scenario 4 (Pessimistic scenario): Average annual growth for Russia 1%, US 3.2%, EU 2.8%, China 8%, World 4%
	2023					2033
	GDP (trillion)	Percent of World	Percent of US	Percent of EU+US		GDP (trillion)	Percent of World	Percent of US	Percent of EU+US
Russian Federation	$2.3	2.1%	10.3%	5.3%		$2.6	1.6%	8.2%	4.2%
United States	$22.9	20.8%	102.1%	52.0%		$31.4	19.3%	100.0%	51.6%
European Union	$22.3	20.3%	99.4%	50.6%		$29.4	18.1%	93.7%	48.4%
US plus EU	$45.2	41.1%	201.5%	102.6%		$60.8	37.3%	193.7%	100.0%
China	$18.3	16.6%	81.5%	41.5%		$43.5	26.7%	138.5%	71.5%
World	$110.0	100.0%	490.1%	249.6%		$162.8	100.0%	518.5%	267.8%