April 02

Russia Annexes Crimea, Economic Hardship Follows

Russian soldiers in Crimea

Russian soldiers in Crimea

Russia’s annexation of Ukraine’s Crimea was a bad idea for a host of reasons; the most prominent of which will be the economic downturn Russia’s economy will face as a result. 

Despite Russia’s booming petrol sector, its economy has stagnated and the country has been struggling lately to stimulate positive economic growth. The reasons for this are many. Firstly Russia’s oil wealth is concentrated in the hands of a select group of individuals with close ties to the kremlin such as Igor I. Sechin (Rosneft), Gennady N. Timchenko (Volga Group) and Viktor Zubkov (Gazprom). The Russian government has maintained a tight grip on the petrol sector and has prevented any real competition within the market, allowing the “Kremlin Elites” to absorb the lion’s share of Russia’s oil proceeds; the country as a whole seeing little benefit. Second, Russia is suffering from a drastic reduction in human capital. Young educated Russians are leaving the country at an alarming rate to Europe and the U.S.  These educated youths see no incentive to stay in Russia, where political freedom is virtually non-existent, employment is scarce, and compensation for labor is minimal at best. Lastly, according to a report titled Russia’s Fiscal Gap (2013):  

How can a country with vast energy resources and foreign reserves and other financial assets that exceed its official debt still have very major fiscal problems? The answer is that the Russia’s energy resources are finite, whereas its expenditure needs are not. Moreover, Russia is aging and facing massive obligations from its pension system and other age related expenditures.

 

Russia’s recent annexation of Crimea will further exacerbate Russia’s economic downturn. Russia has already seen a massive flight of money out of the country since its invasion and subsequent annexation of Crimea. Russia’s net capital outflow was $17 billion in January alone. The impact of this capital outflow was evidenced on Monday when Russian share price indexes dropped ten percent as a result. As both foreign and inward investors become nervous, they are swapping roubles for  western currency. To make matters worse, sanctions targeting Russia’s elite (who have much of their money abroad) in the form of Visa bans and asset freezes (Which the U.S. House of Representatives approved on Tuesday)  will prove devastating to Russia’s oligarchs. If Russia continues on its current path, these individuals will lose access to a large portion of their assets and the economy will suffer as a result. The U.S. and Europe have also made it very clear that should Russia continue to escalate tensions throughout the region, additional sanctions will follow.  

In tandem with government sanctions, private firms have also begun placing pressure on the Kremlin. The Finnish retail giant Stockmann has frozen all expansion within Russia; JPMorgan recently blocked a Russian embassy money transfer to an insurance company. When other private entities follow suite, theses small actions will significantly impact Russia’s economy on the micro level; government sanctions impacting on a macro scale. Combine government sanctions and private sector pressure with the costs which will be associated with administering the Crimea and  Russia’s economy will simply implode.

Should Russia continue trying to revive the old Soviet empire through expansionist policy, the results will prove catastrophic for the Russian economy, which is already teetering on the edge of collapse. In the age of globalization, the current economic integration of the global community requires that all actors involved obey the rules. When rogue states threaten to disrupt the system others will seek to counter the threat through economic sanctions; which due to economic connectivity between states, could prove disastrous to those being targeted. In the 80s we had mutually assured destruction (MAD) which in large part prevented the U.S. and the Soviet Union from going to war. Globalization has created a new version of MAD in which potential economic fallout creates incentive for logical actors to adhere to international norms. Russia’s leadership needs to realize this if it wishes to remain part of globalizations core. Should the Kremlin continue to act irrationally, jeopardizing global stability, the economic consequences will prove catastrophic. Reducing Russia’s economy to economic ash.