Putin’s Economic Solution

As Russia’s recession continues, the Kremlin plans to spend $426 billion on defense through 2020

Photographer: Vitaly V. Kuzmin

Greek Prime Minister Alexis Tsipras, whose country is fighting to stave off financial collapse, was a guest of honor at Vladimir Putin’s annual investment showcase, on June 18-20, along with top officials from China and Myanmar. The event in Putin’s hometown of St. Petersburg drew top European oil executives, such as BP’s Bob Dudley, and a few U.S. business leaders, as well as former British Prime Minister Tony Blair. But the attendance paled in comparison to past forums, when banking titans such as Goldman Sachs Chief Executive Officer Lloyd Blankfein queued up to pay their respects to Russia’s president.

The smaller number of heavyweights at the forum underscores the isolation of Putin and Russia. Foreign direct investment has declined for the last two consecutive quarters. The economy is expected to spend this year and next in recession, assuming oil stays stuck around $60 a barrel. The ruble is down 40 percent from its 2013 highs. Putin’s plan is to wait for oil to rebound, and keep expanding the power of state enterprises, which now account for more than half the economy, up from 30 percent when he became president in 1999.

There’s one area of growth, though, that some analysts see as Putin’s version of a stimulus: Military spending. “It’s clear that the efficiency of the military-industrial complex is the most important source of economic growth,” Putin said at a military forum on June 16.

On May 12, Putin signed documents creating what he called the “industrial battalions” program, which will give thousands of draftees the option of working in defense enterprises instead of joining the regular military. According to federal budget accounts, after years of chronic funding problems for weapons makers, Russia has started to prepay for goods and services it buys from the defense industry, which employs 2.5 million Russians.

Defense, national security, and law enforcement now eat up 34 percent of the Russian budget, more than double the share in 2010. That dwarfs the 18 percent spent by the U.S. last year on defense and national security, according to the Washington-based Center on Budget and Policy Priorities. Still, Americans spent $615 billion last year, while the Russians spent $84 billion.

“The government has two urgent tasks: strengthening security at all levels of society and promoting innovation to end the macroeconomic stagnation,” says Ruslan Pukhov, director of the Centre for Analysis of Strategies and Technologies and a member of a defense ministry advisory board. “The solution to both problems is to intensify the development of the military-industrial complex.”

State-run defense contractors stand to benefit: United Aircraft, which makes Sukhoi and MiG fighter jets; United Shipbuilding, now building a new fleet of destroyers; and Uralvagonzavod, maker of the brand-new T-14 Armata tank. (Each tank costs about $4 million to $5 million to make. Mass production won’t start anytime soon.)

Putin’s former finance minister, Alexei Kudrin, has voiced his opposition to plans to spend 23 trillion rubles ($426 billion) through 2020 on defense. Kudrin says the defense buildup does little to solve Russia’s structural problems and the crisis it faces.

Putin, who warns of a threat from the West and the need for more self-sufficiency, has vowed to spend the full amount budgeted for the military. He’s already ended the Russian military’s purchases from abroad, so the army will buy only from Russian suppliers.

The reformers in Putin’s cabinet would prefer to see their boss cut defense spending and focus instead on overhauling the courts, cutting red tape for small businesses, and stamping out corruption, according to government sources. In his keynote address at the forum, Putin addressed the need to ease bureaucratic barriers that business faces but did not provide any concrete steps for doing so. Instead, he said that the economic crisis predicted by many at the end of last year didn’t materialize. His governmnent “stabilized the situation,” even though the economy slid into its first downturn in six years. Putin said at a June 18 meeting with executives that he expects energy prices to remain low for one to two years, but Russian business has adapted to the situation.

He’s confident energy prices will rise again. As he said at his annual press conference in December, “even if energy prices remain low or continue to decline, there will come a time when energy prices will resume growing when the global economy and the demand for energy grow. I’m absolutely confident that this will happen.” High oil prices and a state-dominated economy delivered average annual growth of 7 percent during his first two terms, and Putin figures they will bring prosperity back to Russia.

“Putin’s model is an efficient symbiosis of feudalism and open markets,” says Andrey Movchan, a longtime Russian investment banker who’s now an analyst at the Carnegie Moscow Center, the Russian branch of the Washington research center. “But his view of the world underestimates the speed of modern development. We’re rushing into a phase when energy will cost a degree less and intellectual property a degree more.”

The bottom line: Putin is relying on oil exports, state-owned companies, and record defense spending to pull Russia out of recession.

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