Special Military Economic Geography: Changes in the Russian Economy by Region

This article by economic geography Natalia Zubarevich provides what seems to be the most vivid and concise snapshot of how the Russian economy is changing under the impact of the 'special military operation' and related sanctions. Looking at the dynamics of economic performance by region provides a multidimensional lens that reveals something that is not otherwise obvious from a sectoral analysis. The fairly decent average figures hide multidirectional dynamics. With abnormal growth and abnormal decline localised, we can look beyond the optimistic figures for the Russian economy as a whole and see the structural transformation it has undergone as a result of abnormal conditions and stimuli of its operation. The artificial reduction of the labour force and the artificial demand for labour related to the needs of the 'Special Military Operation' (SMO) have created the ideal conditions for a wage race. And the expansion of state demand and social programmes leads to a flow of real income from the megacities and high-tech production zones to the periphery, thus reflecting the vector of the underlying structural transformation. — Re: Russia

Industry: Military-Industrial complex replaces the automotive industry

Distrust of Russian statistics is common, especially when the figures do not meet expectations. However, the data published by Rosstat reveals a lot. Let's start with industry: has it managed to adapt to sanctions and the changing environment?

In 2022, the impact of sanctions on the extractive industry was mixed, with the volume even increasing slightly (by 0.8%). Oil production grew by 2%, as sanctions were only imposed in December and companies managed to redirect exports to Asia. Production increased in most oil-producing regions, with the exception of Sakhalin, where it fell by a quarter due to the withdrawal of ExxonMobil from the Sakhalin-1 project. In the coal-producing regions of Kemerovo and Khakassia, the decline in production was more pronounced (a loss of 5-6%), as the sanctions imposed in the summer, combined with logistical constraints on eastward shipments, prevented exports from being fully redirected to other markets. Iron ore-producing regions suffered the greatest decline due to the imposition of sanctions on exports of metallurgical products to the EU. Despite a 13% decline in gas production in Russia as a whole, the main gas-producing region, the Yamalo-Nenets Autonomous District (YNAO), saw its output fall by only 2%, driven by an increase in oil production.

In January-April 2023, the performance of the extractive industries deteriorated (-2%). The decline in the YNAO (-8%) was exacerbated by the loss of most gas export markets, a slow decline in the main oil-producing region — the Khanty-Mansiysk Autonomous District (-0.2%) and an even more significant decline in the oil-producing regions of Siberia (Krasnoyarsk Territory, Irkutsk and Tomsk Regions — by 6%). If the production restrictions announced by the Russian authorities are implemented, this decline will accelerate. By contrast, the coal and iron ore-mining region of Kemerovo has been able to mitigate or overcome the downturn.

These multidirectional dynamics are easy to understand: those hit by sanctions in the summer of 2022 are gradually adapting to them, the dynamics are different in the various oil regions, and are deteriorating in the main gas region. Generally speaking, the instability in the extractive industries is limited and not critical.

Trends in the manufacturing sector are also fairly straightforward. It grew by 3% in January-April 2023, after a slight decline in 2022. The above-average growth seen in regions with a high share of defence companies began in autumn 2022 and became even more pronounced in 2023. These include a third of central regions (Tula, Ryazan, Yaroslavl, Tver, etc. — 9-19% growth), Udmurtia (21%), Penza (15%), Sverdlovsk and Chelyabinsk (10%), and Omsk (9%). Growth in manufacturing also continued in regions with a high share of the enterprises in the food production sector (Krasnodar Krai — by almost 13%).

The situation is different in those regions where there is a high share of sanctioned industries. Regions in the north-west specialising in timber processing, which have suffered greatly from the loss of European markets, are only slowly emerging from the recession. Regions with high numbers of ferrous metallurgy enterprises are growing at a slightly higher rate as companies develop their logistics to access alternative markets.

Mineral fertiliser producers have fared worse (Novgorod Oblast — 9% decline in production, Murmansk Oblast — 16%, Perm Krai — 2%): although they have not been subject to sanctions, export volumes have not recovered. At the same time, global fertiliser prices remain high and companies' export profits still outweigh the decline in export volumes.

The most severe recession persists in the automotive-producing regions, which foreign companies have left(Kaluga and Kaliningrad oblasts have seen a 16-17% decline in production). Finding alternatives to the assembly of Western car models remains a challenge.

Nationwide Construction: Border regions and eastern testing grounds

The statistics for construction are even more striking. Nationally, construction grew by 7%, but in the Southern Federal District it grew by 36%, including an increase of 60-64% in the Republic of Crimea and the Rostov region. It is easy to guess what might be being built in the vicinity of the 'SMO'. In any case, this anomalous surge is probably not related to the 'natural' needs of the economy. The high rate of construction growth in Volgograd Oblast, Stavropol Krai and Chechnya is more difficult to explain, as these regions are further away from the 'contact zone'.

Other areas of accelerated construction growth are seen in Far Eastern regions along the Trans-Siberian Railway (Khabarovsk Krai — 83% growth, Zabaikalsky Krai — 55%). This is the result of the modernisation of the Eastern Polygon of the Trans-Siberian rail line — the expansion of transport and logistics infrastructure to increase its throughput capacity due to the reorientation of major commodity flows towards Asian markets. Construction in Moscow is growing less rapidly but at a steady pace (+17%), and the city's infrastructure is developing despite the odds.

The effects of the 'SMO' and its impact on the regional economy are also reflected in the dynamics of investment. Compared to 2022, investment growth has slowed. Last year saw an increase in budgetary investments and corporate acquisitions — it was necessary to replenish stocks of equipment and components through parallel imports. In the first quarter of 2023, investment growth in the Russian Federation as a whole was minimal (0.7%), as the share of budget funds fell to 13% and the growth of business investment slowed. The figures for the beginning of the year may see a further change, but it is unlikely that an investment boom can be expected in 2023.

Regional fluctuations in this area also reflect the changing circumstances of the 'SMO': in the Southern Federal District investments grew by 26%, including 74% in the Rostov region, where the share of federal budget investments reached 44% for the first time (in previous years it never exceeded 15-20%). The second area which saw a significant increase in investment was the Far East (27% growth), which saw investment growth in all its regions, except Sakhalin. This means that they were not only targeting the development of the transport corridor to Asia. However, the structure of investment is largely explained by a relatively high share of bank loans (15%, while the national average is less than 10%) and a low share of budget funds (less than 6%, while the national average is over 13%). These data points suggest that the federal government has shifted much of the burden of investment in the Far Eastern regions onto the shoulders of large Russian companies and state corporations, giving them access to loans from state-controlled banks.

More generally, infrastructure investment, much of it forced, has become an important anchor for the economy in the face of the sanctions shock.

Redistribution of Consumption: Restaurants instead of IKEA

The situation in the private consumption sector is also mixed. After two years of rapid growth (11-13%), housing construction has started to decline, with new housing projects falling by 4% in January-April 2023. This was to be expected for two main reasons. First and foremost, there have been problems with sales of the multi-family homes that have already been constructed. Demand fell in the spring and it is estimated that up to 40% of the apartments put on the primary market in Moscow did not find a buyer.

Second, the figures for 2022 were 'inflated' by the statistics on the commissioning of family houses and dachas. Their share in the total volume of new housing projects in the country reached two-thirds, and in the Moscow Oblast it was three-quarters (the Moscow region contributed the most to the dynamics of housing construction — almost 14% of the total volume of housing commissioned in Russia). In reality, these individual houses and dachas may have been built a few years ago and their owners hurriedly filled out documents for 2022, hoping to gain access to the free gas connections announced by the federal authorities. However, this effect is finite and a statistical decline is inevitable for 2023. This is already evident in the figures for the 'growth champions' of 2022: in the Moscow region, the number of new housing projects fell by a third in January-April 2023 , and in Chechnya they dropped by half. Among the largest megacities, only St. Petersburg saw a large drop in new housing projects (down 15%), while Moscow saw a 17% increase after a downturn last year.

Retail trade is slowly recovering from the crisis of 2022, when it declined by 7%. In January-April 2023, the decline slowed to -3.6%. Food trade contracted slightly (by 1.6%); the decline in non-food trade (-5.4%) was slower to recover due to the decline in car sales and the withdrawal of many global companies (IKEA, retail chains) from the Russian market. The worst dynamics occurred in the two largest agglomerations, where global chains were most present and car dealerships were concentrated. In January-April 2023, the decline in non-food retail in Moscow, St. Petersburg and the Moscow region was 11-14%, but this fares significantly better than 2022 when this decrease was 16-22%. The population is gradually getting used to the changed and more expensive range of goods; in addition, the low base effect of April 2022 has started to have an impact.

It is important to note that the retail dynamics seen in 2022 and early 2023 should not be taken as an indicator of declining household incomes, as the main factor behind these changes is a reduction in the supply of non-food products rather than a reduction in demand. Once again, geography plays a role: in the Southern, North Caucasian, Volga and Ural Federal Districts, the population has already adjusted and retail turnover has exceeded the level of January-April 2022. In the South this can be explained by the weak penetration of global retail chains, but this explanation seems insufficient for the Volga and Urals where there are questions over the validity of the available data.

The most striking indicator is the dynamics of catering turnover (restaurants, cafes, bars). These can be used to understand the main feature of the Russian population's adaptation to their changed lives — the desire not to notice the new realities, to live as they did before, to 'drown out' problems with delicious food and drink. Even in the turbulent year of 2022, catering sales grew by almost 5% at comparable prices, thanks to the lifting of the Covid restrictions (the low base effect of 2021) and the growth of domestic tourism. Growth accelerated to 12% in January-April 2023 and to 19% in Moscow. Geographically, the indicator also reflects the effects of the 'SMO': in Sevastopol and the Republic of Crimea, catering sales grew by 2.2-2.4 times, and in the Rostov region by 77%. There is an obvious reason for this: a lot of men with good appetites travelled to those areas...

It is generally believed that during hard times people save money on services. Some of them are the easiest to cut back on. However, the volume of paid services grew both in 2022 (by 3%) and in January-April 2023 (by 5%). In Moscow, this growth was even higher — by 11%. If, in 2022, this could be put down to an increase in the cost of housing and utilities (two tariff indexations during the year), in 2023 there was no indexation, only an increase in public transport fares.How then can we explain the fact that the overwhelming majority of regions recorded an increase in the volume of paid services in real terms? One hypothesis is very banal: it is difficult to buy a car and furniture, and it is expensive to go abroad, so citizens relax, have fun and get paid medical treatment closer to home. A more rigorous explanation sounds something like this: in 2022 and early 2023, disposable income barely fell, but dramatic changes took place on the supply side — i.e. when it came to what could be consumed with this income. The supply of durable goods deteriorated in price-quality terms, and consumption in areas such as foreign tourism fell sharply. This led to changes in consumption patterns that are atypical of previous Russian crises.

Low unemployment or labour shortages?

The state of regional labour markets has become a source of pride for the authorities: despite the crisis, unemployment fell — both as measured using the WTO methodology and as officially registered by the government. Normally, falling unemployment is a sign of rising employment and a recovering economy. This is why the authorities are so proud of their 'achievement'.

In this case, however, the reasons for such dynamics are only marginally, and in a very specific way, related to employment growth. The main reason for this trend is the reduction in the young working-age population by more than a quarter, due to the peculiarities of the Russian age pyramid. The second reason was the mobilisation of 300,000 men who have dropped out of the labour market (most of them were living in small and medium-sized towns and rural areas) and the emigration of at least half a million people, mainly residents of large cities. As a result, the WTO-calculated unemployment rate is very low (3.4% in February-April 2023) and below the national average in most parts of the Central, Volga and Ural regions and in half of the regions of the North-West and Far-East.

Figures from 2022 and early 2023 also suggest that there is no problem of underemployment, typical of Russia's crisis periods. But there is another factor to take into consideration — an acute shortage of labour. Those employed by companies in the military-industrial complex are in the best position, with workers receiving a doubling of wages in autumn 2022 and a guarantee against mobilisation. However, the available figures do not show whether these companies have managed to fill their second and third shifts with workers.

In non-military sectors, the problem of staff shortages is growing rapidly, especially in the more labour-intensive sectors of manufacturing and construction. A wage race has already started to poach workers, especially highly skilled blue-collar workers. Since October 2022, real wages have been rising (according to data for companies and organisations), and not just because of a slowdown in inflation. In the first quarter of 2023, growth accelerated to 1.9% and reached almost 3% in March. Therefore, there is not and will not be an increase in unemployment. The problem is of a different nature: the labour force in Russia is shrinking — both for natural and unnatural reasons — and in these circumstances there is little likelihood of sustainable economic growth.

Why Incomes have not fallen

The most frequently interrogated data are statistics on the real incomes of the population. Indeed, their measurement at the regional level raises many questions, due to insufficient sampling of the households surveyed among other issues. In 2022, the relatively soft decline in the population’s real incomes as a whole (by 1.5% according to the adjusted data) was met with disbelief. In the first quarter of 2023, these figures rose, albeit by a negligible 0.1%.

There are good reasons for this trend. Since the summer of 2022, low-income families with children aged 7-17 have been receiving monthly allowances; the Ministry of Finance has allocated almost half a trillion rubles for this purpose until the end of the year. In 2023, low-income families with children will move to a single allowance, based on income and assets. This allowance will cover 10 million children and the amount of payments in 2023 will amount to significantly more than 1.5 trillion rubles. You might recall that, at the end of the 2010s, one in five children in Russia lived below the poverty line, with family incomes below the subsistence level. Support for low-income groups has become a priority and has its own geographical configuration: the share of the poor is higher in rural areas and small towns, as well as in less developed regions, including the republics of the North Caucasus and South Siberia, where the process of demographic transition is incomplete, i.e. in the periphery.

There was also a 10% indexation of pensions in 2022. This was repeated in 2023, with real pensions rising by 7% between January and April, a matter helped by low inflation. The elderly population — the backbone of government support — is consistently supported, and its share is highest in the heavily ageing regions of the Centre and North-West, and to an extent in the Volga region.

In addition, the minimum wage was increased by 10% in 2022, forcing companies to increase their workers’ pay. This decision places an additional burden on budgets, which have had to increase the salaries of public sector employees. Deputy Prime Minister Tatyana Golikova has already announced that the policy of raising the minimum wage will continue. The task is clear: to make businesses 'splurge', alongside the increase in budget spending, which will lead to an increase in wages and consumption. Other tools have also been used to stimulate this area of the economy: in 2022, small businesses were allowed to postpone insurance payments to non-budgetary funds until the following year, when the federal budget would pay them (about 770 billion rubles). This measure made it possible not to 'cut' the salaries of people working in small businesses despite the crisis, which was primarily a help to those in big cities where small businesses are concentrated.

Payments to those mobilised began in the autumn of 2022. Given the payment declared by the authorities of almost 200,000 rubles per month and the number of those mobilised (300,000 people), the corresponding monthly budget expenditure can be estimated in the region of nearly 60 billion rubles. As mobilisation was, generally speaking, carried out more actively in medium and small towns, rural areas and less developed regions, families in Russia's semi-periphery and periphery received additional financial resources. This mitigated the decline in real incomes, and even brought this decrease to a halt in 2023, maintaining a sense of normalcy for many Russians through income growth. It is clear that these costly social policies will continue at least until March 2024, allowing the authorities to report rising personal incomes and a decline in poverty by the time of the presidential elections.

Peripheral Beneficiaries: Where have incomes grown?

The regional dynamics of real income are difficult to explain because of the limited reliability of Rosstat data. The vast majority of regions were in recession in 2022, and their dynamics varied, but it is difficult to analyse these due to the insufficient accuracy of the measurements. It can only be noted that the highest rate of decline in real incomes was observed in the automotive-producing regions (Kaluga, Kaliningrad Oblast — a decrease of 6-8%), where industrial production fell sharply and some workers were transferred to part-time employment with a reduction in wages.

In the first quarter of 2023, real incomes fell in only 15 regions, most noticeably in the Kaluga, Vologda and Murmansk regions (by 3-4%), where industrial decline continued. It is more difficult to explain the fall in incomes in the Amur and Magadan oblasts (a fall of 5-6%) where it appears to be a matter of data accuracy. Despite all the shortcomings, the statistics suggest that the population support measures have been successful and helped to overcome the decline in real incomes in most regions.

We cannot quantify how much of the additional payments from the government went to residents of areas in the semi-periphery and periphery, but statistics suggest that higher rates of real income growth (3-6%) were enjoyed by most of the less developed regions and some of the regions where industry specialises in the military-industrial complex. In Moscow, however, real incomes fell by 2% in the first quarter of 2023 and throughout 2022. This is despite the fact that they did not fall during the 2020 pandemic crisis, and in 2021 they grew faster (by 8%) than in the rest of the country (4%). A significant number of high earners may have left the country.

Could it be argued that the state’s aid priorities have shifted towards the periphery, leaving the largest cities behind? This would be a stretch, as real incomes in St Petersburg grew in the first quarter of 2023, albeit barely (by 0.2%). Most likely, the authorities' decisions were not based on geographical considerations and they had other tasks in mind: to ensure the growth of the military-industrial complex, to support pensioners as a core electorate, to ensure the growth of real incomes and the reduction of poverty by the next elections. Regional income dynamics partially reflect these objectives, but not linearly.

Regional Budgets: the transfers and taxes dialectic

The most reliable way of assessing the situation in the regions is to analyse their budgetary revenue and expenditure. Unfortunately, data is only available for the first quarter of 2023. It shows that, compared with the state of the federal budget, the problems of the regional budgets are not so great, their own revenues (tax and non-tax) have grown by 6% (excluding the 'new territories' in occupied Ukraine).

The growth of all revenues of consolidated regional budgets (including transfers) was higher — by 10%. Many types of taxes demonstrated good growth: income tax revenues increased by 18%, property taxes by 45% and excise duties by 10%. However, personal income tax (PIT), which is the main tax in most regions, fell by 20%, as did taxes on total income, most of which are paid by small businesses. The reason for these trends is not economic but institutional, linked to the difficulty of transitioning to a Single Tax Account (STA) in 2023. The transition has long been planned, but it is not going smoothly as, for example, not all payments are accounted for, and automatic rebates of income tax overpayments destabilise the budgetary system, etc. These are technical problems that should be solved within a year or so. The federal government is aware of these issues and is trying to contain the problem by increasing its support to the regions.

Transfers from the federal budget increased by a third in the first quarter of this year, including 47% for grants and 62% for subsidies. The sharp increase in federal aid is not only related to financing national projects and easing problems associated with the transition to a single tax account — a quarter of all grants to the regions were allocated to the 'new territories' in occupied Ukraine. Transfers account for 93-97% of the revenues in these areas, and they are far ahead of Chechnya and Ingushetia in terms of subsidies. This is a very expensive situation...

Expenditures of consolidated regional budgets grew twice as fast as revenues in the first quarter, increasing by 20%. Expenditure on the national economy saw the greatest increase (growing by 39%). This was mainly due to a 36% increase in spending on road construction (the need to implement national projects has not gone away!), supported by a sharp rise in subsidies.

In addition, assistance from Russia’s regions to the 'new territories' - sending workers, building materials, equipment, etc. — is taken into account in national economic expenditure. In effect, this is a 'SMO tax', which is paid mainly by regions with high and medium fiscal capacity; the underdeveloped regions supply the human capital mobilised for the ‘SMO’. Expenditure on housing and utilities also grew rapidly, by 25%, which is also linked to the implementation of national projects. Social expenditures (social support) lead this growth, rising by 15%. This includes payments from regional budgets to the families of the mobilised, wounded and killed (in addition to federal payments). The increase in spending on education (13%) has outstripped inflation (remember that budget revenues and expenditures are measured in rubles): schools are being built and repaired in Russia as part of the programme of national projects. Expenditure on healthcare has fallen by 10%; it has fallen in a third of regions and this was particularly acute in Moscow (almost double the decline in other regions): Covid is a thing of the past...

Some concluding thoughts

In 2023, most regions have adapted to their new circumstances, and the military-industrial regions have even made some economic gains.

Businesses have also largely adapted, finding new supply channels and markets. New sanctions, if imposed, will not be able to break these links. So far, the automotive industry, household appliance production and non-food retail have failed to adapt, although the latter is showing signs of gradual recovery.

The federal government's policy of supporting industries and regions has yielded positive results, but its long-term financial capacity is unclear. Support for regional budgets is unlikely to decrease, as it is a factor of political stability (over 60% of all regional budget expenditure is for social purposes, leaving teachers without salaries would be risky), but funding for national projects may be optimised after 2023.

State support for citizens in the semi-peripheral and peripheral areas (medium and small towns, rural areas, less developed regions) has increased, functioning to maintain a sense of normality for residents and providing the authorities with a 'safety cushion'.

Russia is facing two main economic challenges. One is a declining workforce, which will inevitably stall recovery growth and the so-called structural transformation. The second is uncertainty about the future of federal budget revenues and the state’s ability to support industry, regions and the population, while still funding the 'SMO' and the state defence order. There is enough money for 2023, but what will happen after that?

It is sometimes said that the situation in Russia is becoming reminiscent of the late Soviet era, with its ruinous arms race. However, in a market economy (and Russia is still a market economy) it is impossible to find a perfect analogy; the economy is trying to adapt and even evolve. So far it has succeeded in doing this, but will it be able to do so in the coming years, when costs are rising and the state's financial resources are shrinking as a result of the contraction of raw material rents?