The War Budget and the Race to the Bottom

The State Duma has adopted next year’s budget. Its main feature is the sharp increase in military spending, which has been increased almost 1.5 times when compared with the original spending proposal. This is necessary, above all, to replace the supplies of weapons and equipment that have already been depleted by the war in Ukraine. Experts have expressed doubts that this money will be enough to compete in the conventional arms race with the West; they hold the opinion that, in the long run, it will completely undermine the Russian military and economy, while remaining relatively easy for the West to absorb the costs. Therefore, the question of whether Russia will bring about the collapse of its own economy through exorbitant military spending for the second time in fifty years appears to be very much open to debate.

Mission Impossible — 1

Russia will not be able to recover its military equipment losses in the foreseeable future, despite the sharp increase in defence spending. This will, in turn, lead to considerable strain on the budget, according to a review from military analyst Pavel Luzin, published by the Center for European Policy Analysis (CEPA).

After February 24, spending under the heading of ‘National Defense’ within the 2022 budget increased from 3.51 trillion to 3.85 trillion. In addition, another 2.82 trillion was allocated for ‘National Security and Law Enforcement’. This second pot of money includes the budget for organisations such as Rosgvardia (the National Guard) and the FSB. Luzin asserts that this also partially covers Russian mercenaries, for example PMC Wagner. So, a significant portion of these budgeted funds are also being directed towards the war in Ukraine. But, in reality, spending on the war is even higher.

This increased expenditure is indicated by monthly updates of national defence spending, which were not classified until June. In March and April they amounted to about 500 billion rubles per month. Extrapolating these figures suggests that military expenditure will be in the region of 5.5-5.6 trillion rubles by the end of the year, compared to the official sum of 3.85 trillion rubles. Such a drastic increase in expenses is primarily due to considerable losses of military equipment, and the need to replenish these losses, Luzin says. In June there was a plan to increase defence spending by 600-700 billion rubles, but since then this sum has grown considerably. It is also very likely that spending on national security and law enforcement agencies will be higher than initially planned.

Thus, taking into account the figures that Luzin was able to extrapolate, total defence and security spending this year may amount to more than 9.5 trillion rubles. Such rapid growth in defence expenditure will cause great strain on the budget system, especially considering the decline of several revenue streams. Initially, revenues of 25 trillion rubles and expenditures of 23.7 trillion were allocated within the budget, but now the expenditures have been revised to 29 trillion, while the proposed revenues have stayed the same. Such a ratio would mean double-digit deficits, but much of this will be covered by additional revenues from Gazprom and funds from the National Welfare Fund.

In the 2023 budget, which was approved by the Duma in its third reading, the planned defence spending currently stands at 5.1 trillion rubles, with another 4.42 trillion for national security and law enforcement agencies. This amount totals about the same as the 9.5 trillion that Luzin has calculated for the current year. Just as in 2022, spending on defence and security will increase almost 1.5x (by 45%) in nominal terms, and about 30% in real terms (adjusted for inflation), compared to the pre-war budget (3.5 trillion and 2.97 trillion rubles, respectively).

However, Luzin underscores that the increase in financing will not solve the issue of military equipment shortages. The Russian defence industry is unprofitable and inefficient. From 2016 to 2020 alone, the overdue loans accrued by the industry totalled 1.7 trillion rubles. And, in the context of sanctions, it seems unlikely that defence enterprises will be able to increase their profitability. Therefore, the only solution is to simplify production, which in this case means issuing obsolete weapons. However, this is only possible in the production of tanks and armoured vehicles, not in aircraft construction and the production of high-precision weapons. For example, Russia has lost 27 KA-52 helicopters on the battlefield since February, but is only technically capable of producing 15 of these vehicles a year. A similar situation can be observed in the production of many other types of weapons. The shortage of personnel within the military-industrial complex is another significant problem, which, within the context of mobilisation, is unlikely to be solved.

Mission Impossible — 2

Thus, the war economy is becoming another challenge for the Putin regime. The prominent British expert Timothy Ash, in a column published by CEPA following Luzin's analysis, has also expressed similar views regarding the Russian military economy. He believes that the attempt to rebuild or replace destroyed weapons and the new conventional arms race that Russia has entered into with the West, all occurring within the context of sanctions, will ultimately bankrupt the Russian economy. As Ash speculates: "How can Russia hope to win an arms race if the West's combined GDP is $40 trillion and its defence spending, which is 2% of GDP, is well over $1 trillion (when one considers the disproportionate contribution of the United States to defence)? While Russia's entire GDP is just $1.8 trillion."

Ash's main argument is a response to the criticisms levelled against the Biden administration from some Republicans and supporters of Donald Trump in the US. The Biden administration received congressional approval for $40 billion in aid to Ukraine in 2022 and requested an additional $37.7 billion by the end of this year. Half of this aid was earmarked for defence. At first glance, these amounts seem enormous, but if you compare them to U.S. military spending in 2022 ($715 billion), defence assistance to Ukraine is just 5.6% of the total sum. At the same time, this expenditure critically undermines the defence and economic potential of Russia, which today acts as one of the main adversaries of the United States. Ash argues that if this is truly the case, spending on Ukraine looks extremely efficient, meaning it allows Washington to neutralise the Russian threat and weaken its military power without much investment or risk toAmerican lives.

Moreover, as Ash writes, the war has undermined the myth that Russia possesses advanced military technology. The war will critically undermine Russia's position in the global arms market. In recent years, Russia has regularly ranked among the top three military exporters, but now conventional buyers of Russian weapons may opt for more expensive but higher quality American equivalents with better specs. The Ukrainian army receives "second-generation" weapons from the West, but even these enable them to win on the battlefield and to take offensive action against Russian forces. War is a showcase for demonstrating the capabilities of military equipment in real-life conditions. And, most buyers will prefer to purchase military technology that has been developed by the victors. Putin has provided a unique marketing opportunity for Western competitors to demonstrate the advantages of their military technology over that of Russia.

Finally, active support for Ukraine provides the U.S. with two other strategic advantages: first, it demonstrates to China the ramifications of a possible attack on Taiwan, and second, it squeezes Russia out of the European energy markets, opening up opportunities to export more expensive American gas to replace cheaper Russian gas.

In any case, defence and warfare spending was the top priority in the Russian budget for 2022; defence itself was 18% of all budgetary expenditures, and combined defence and law enforcement accounted for a third of all budgetary spending. The planned actual budget deficit (expenditures exceeding regular revenues) this year and next is unlikely to lead to the collapse of the Russian economy. This is particularly the case given that, next year, the Russian authorities intend to partially cover this deficit by mobilising revenues from the primary sector and the resources of the National Welfare Fund (the use of which is, in essence, money issuance, but looks better in reporting). However, a sharp increase in war spending will certainly complicate the situation for the Russian economy, which is under heavy sanctions.

The tight budget situation will force the government to restrain social spending and limit support for the economy, including plans to replace critical imports. It will also hamper investments in infrastructure, which, as we covered earlier, is especially important within the context of Russia's forced reorientation of foreign trade towards the east. At the same time, Russian exports are also likely to see a marked decline next year, which will lead to a further increase in the budget deficit. As a result, the economic situation may turn out to be even more strained than this year, and the outlook for citizens looks worse next year than this year. This, in turn, will put political pressure on the authorities to increase social programs and support enterprises that find themselves in dire straits. Although the collapse of the economy may be difficult to imagine today (just as it was in the mid-1980s), this rarely occurs as the consequence of a single shock. Rather, as a result of a series of events, during which economic and political factors deteriorate and a crisis spiral unfolds.

Therefore, the issue of whether Russia will bring about the collapse of its own economy through exorbitant military spending for the second time in fifty years very much remains to be seen and is open for debate.