Annex to Remember
As the Ukrainian military continues to make gains having liberated almost the entirety of Kharkiv oblast', made further progress in Donbas, and around Kherson, ministries in Moscow are now coming under pressure to deliver after Putin's frequently bizarre address to the nation. Minister of Finance Anton Siluanov has reportedly committed to allocating funds from the 2023-2025 budget to revive the economies of annexed territories in Ukraine, though he has not put a number on the relevant spending nor does the Russian government have any idea what their actual boundaries will look like. The following is a handy graphic from RBK on the regions being annexed, their populations, and turnout for voting that requires no translation. We see the arc of Luhansk Donetsk, Zaporozhe, and Kherson (descending order geographically):
Add to this the latest map from Rybar' on Telegram around Kherson showing the scale of the withdrawal yesterday and likely continued withdrawal today from what we know so far:
Siluanov's announcement comes just as the Federation Council has formally ratified the accession of the Donetsk, Luhansk, Zaporozhe, and Kherson regions into the Russian Federation. What I find striking about the present situation is just how novel it is to be announcing these kinds of spending plans. One need only look at the process of integrating Crimea, a region that did not suffer any systemic damage from years of sustained fighting culminating in frequent instances of intentional sabotage, sustained artillery barrages, and other causes of dislocation and destruction. Last year, an analysis from Bloomberg estimated the long-run cost of the annexation of Crimea at $150 billion (presumably including losses from sanctions and worsened growth). Nominal budget forecasts seem to imply real-terms cuts to services given falling revenues and the costs of mobilization (h/t Elina Ribakova):
We can see this reinforced by the Ministry of Finance's expectation that revenues from mineral extraction taxes levied on the oil sector will be 2.8 trillion rubles lower in 2023 than 2022. These are paired with a commitment to avoid any external sovereign borrowing and limit domestic bond issuances to the range of 2-3 trillion rubles annually over the next 3-year budget cycle. That's a comparatively low figure given that OFZs are supposed to be an asset undergirding ruble-denominated lending by the banking sector and lending expansions are necessary to prevent larger declines in investment and output. A paltry 25.6 billion rubles have been committed to restructuring the debts of large firms under current plans, and as far as I can tell the scale of restructuring will have to rise as the Bank of Russia pivots to address what it sees as a pro-inflationary environment:
What's simultaneously shocking, and yet unsurprising about the current round of austerity is the degree to which it intensifies the neoliberal coercion that the regime has relied upon for decades and turned into a sort of sport during the worst of the pandemic in 2020 and 2021. Regional governments, local governments, unitary enterprises (lovely corporate structure holdover from the late 80s), and various fiscal/monetary authorities have been given the legal right to make defense procurements. This notably includes drones, which seems like a roundabout way of encouraging more parallel import schema or complex import/export transactions to get kit into the country. In practical terms, this is akin to ordering regional governments to cut spending on the provision of public goods and services in support of the war at the same time other important initiatives reacting to public protests such as the ongoing waste management reforms (marginal budget items ultimately) are seeing their federal support cut. Not only has the Ministry of Finance quashed regional autonomy for nearly a decade by effectively controlling the level of permissible indebtedness and debt issuance among regional governments, but also mandated their indebtedness to the federal center through successive waves of unfunded mandates backed by the Kremlin. Pandemic policies shunted virtually all responsibility onto local and regional authorities to keep hospital systems together and the public as safe as possible, leading to a patchwork of differing regional approaches frequently undermining each other and utter chaos. The excess mortality data comparing the US and Russia shows that though admittedly they are very different state capacities and federal powers, but nonetheless more comparable in terms of political structure:
Regional civil servants, members of parliament, and municipal deputies are eligible for conscription, likely out the regime's need to create the impression that political leaders and elites are bearing the burden too, and the governor of Yaroslavl' oblast' has gone so far as to announce the regional government is cutting one-third of the jobs in its administrative organs by year's end. In many cases, positions aren't necessarily all filled (and higher-ups pocket those salaries for themselves) but the move is intended to allow the government to redirect some of the funds allocated to it to raise the salaries of those who survive the chopping block and bind them further to the state. Talk of budget sequesters across the regions have quickly emerged with fears that they'll end up cutting regional budgets 20-30% at the same time regional piles of cash are effectively militarized and mobilized for war purposes. Even Moscow has seen its monthly revenues decline significantly since May.
And it goes beyond pressure on the regions and local authorities. Mobilization has unleashed a wave of consumer spending on medical and related goods in anticipation of men being sent to the front at the same time it has discouraged those same men from going out for drinks or meals or otherwise exposing themselves to situations where they could be rounded up if they can't get out of the country. Prices and demand for basic medical and consumer goods that might be handy for those being mobilized are up 10-20% as men prepare for shortages when they get to the front. Demand at sperm banks to freeze sperm in case of death or otherwise for family planning has reportedly tripled since mobilization began. In the current environment, even more strangely purchasing manager indices for manufacturing show an improvement in September:
Yet the Russian Union of Industrialists and Entrepreneurs has its own data showcasing that business sentiment remains negative, though it has stabilized since August. Any increase in manufacturing output can only be explained through war-related stimuli that end up destroying consumption and value elsewhere across the economy. Steelmakers are a good bellwether – they report growing pressure on their continued profitability due to the combined effects of a stronger ruble, sanctions-related discounts on exports, and massively heightened logistical costs from the mass foreign firm pullout on the national logistics market such that transport now accounts for 30% of the end prices they qoute customers instead of 10%. Reorienting exports to China and Asian markets has significantly raised logistics costs since most of the major metallurgical industrial centers in the Russian economy are either in European Russia or Western Siberia along routes designed to be moved to Europe before being sold to end consumers. Russian Railways is waffling over whether or not to provide discounts on tariffs for metals products because the metallurgical firms themselves can't guarantee production volumes, therefore undercutting the financial stability RZhD needs to balance its capex program against worsening constraints on fiscal support. If exporters are struggling, that always shows up in reduced domestic demand structurally in Russia. That it isn't yet suggests there's a ton more resource allocation towards the war effort than may meet the eye, throwing further cold water on the topline GDP figures touted by the regime.
As all of these difficulties mount, you'd be hard-pressed to find anything politically popular in what Siluanov was announcing about paying for the newly annexed territories' revival. Money has become a zero-sum proposition in Russia. There is no growth. There is no easy way to convert US dollars or Euros into reliable purchasing power. One need only look Alex Isakov's fantastic graphic about Turkey's role absorbing Russia's FX reserves and current account surplus to spot that problem:
There is also no means of dividing wealth more equitably. Russians are literally being forced to dip into their savings to pay for the mobilization as they themselves are sent into the meatgrinder. Buying loyalty now requires cutting spending somewhere else, which then continually compounds the regime's dependence on every form of coercion at its disposal.
A recent piece by David Szakonyi on the evolving nature of corruption in Russia is both a fantastic overview of how the regime can reconstitute or refashion its durability amid the current crisis and also a reminder of the degree to which the macroeconomic context and political understanding of 'stability' in the Russian state reinforce each other. Consider the example of public-private partnerships (PPPs). Research shows just how far Russia lags behind more developed peers when it comes to its public-private partnership market (usually under 2% of GDP annually), the degree to which this gap likely worsens regional inequality, and the particularly capital-intensive nature of projects in certain regions. The flurry of spending pre-COVID noted below was primarily a means of individuals monetizing political access winning contracts that supported the national goals from Putin's 2018 re-elect that have largely been for nothing and been delayed till 2024 or 2030 prior to the invasion this February:
Many of these projects amount to legalized forms of corruption. Back in 2017, there were a series of dueling ministerial directives and legal decisions between the Ministry of Finance and Ministry of Economic Development over whether or not PPPs that were fully guaranteed by the state i.e. state funds either financed 100% of construction or service delivery or a private sector actor was guaranteed at least 90% of any spending would be returned within 1-2 years regardless of project completion qualified as state procurements. It's a very arcane matter that few in the West gave much mind to, but it goes a long way towards explaining why the current situation is such a problem for contexts in which graft is used to glue together political support. These projects have continued on as de facto procurement projects without being legally defined as them. As regional budgets tighten, there's yet more pressure to try to crowd in private investment to offset what the state can't or won't spend, but at the same time regional governments' resources to guarantee returns on investment are being axed. None of this even considers the issue of worsening uncertainty generated by mobilization and risks that key workers in various industries be sent to fight.
Szakonyi's piece elaborates the ways in which corruption in Russia is increasingly organized rather than rogue as fiscal/financial pressures on the state mount. The pie is no longer growing and there'll be less nibbling at it around the edges by countless chancers sucking money out of the state. Corruption in Russia is a bit like constant, iterative games of high stakes Jenga between elites, the state's apparatuses, and federal center. If the nation's wealth is a tower of wooden blocks, the aim was to pull a piece away here or there without upsetting the tower so much that it fell, leading to a political intervention from above or response from a more powerful elite or interest group. The current sanctions regime, hit to revenues, and commodity market context are taking blocks out from the base. Instead of allowing the raiding to continue so long as individuals adhere to the rule of stealing without being a thief (to think in Stanovaya's terms), blocks are being reallocated to shore up the base of the tower and discipline imposed upon any who break this scheme. Digital oversight via the Poseidon program and Federal Protective Service, a means of directly monitoring and disciplining the various layers of middle-managers in Russia's bureaucracy or enterprises, further centralizes control over rents at a time when they're fewer to come by.
The question is who wins out when the consensus that can be more tightly managed by figures like Mikhail Mishustin, Sergei Kirienko, and Putin himself runs so flagrantly against public attitudes and interests. Imposing discipline on the organs of state is crucial in cracking down on the kind of open corruption that inspired so much public anger in years past, yes. Doing so when imposing discipline on the public for a war they don't particularly support and one that the regime now appears to be losing in the middle of what will likely be an accelerating degradation of domestic economic conditions is quite different. That so many people are employed by the state or state-owned companies makes is a core strength of the regime's construction. But it's telling that pay-rises are increasingly paid for through cuts to existing positions within the state (many of which are themselves corrupt schemes for officials to collect salaries they can pocket) and eventually state-owned enterprises as the profitability of major exporters falls. The material rewards of loyalty are diminishing as is the pool of people that can be bought. The problem with the current emerging attempt at neoliberal totalitarianism in conditions that preclude the effective recycling of a large trade surplus is that eventually you run out of someone else's money. In those conditions, you can build regime capacity, not state capacity. Unfortunately, it's state capacity that wins wars.
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