In this article, I want to concentrate on the economic causes of this disaster and its implications not only for the future of Ukraine and Russia, but also for the world economy. Of course, economics cannot be divorced from politics; each plays on the other. But to paraphrase Friedrich Engels: in the last analysis, history is driven by material conditions. [1] And as Lenin said, “politics is concentrated economics.” [2]

For the economic causes of this war, we must go back to the collapse of the Soviet Union in 1990 and later, the intense economic crisis in Ukraine in 2013–14, which eventually led to the overthrow of the pro-Russian (but elected) government in Ukraine by the so-called Maidan Revolution (named after the square in the centre of Kyiv, Ukraine’s capital). Russia reacted to the fall of the pro-Russian government by annexing the Crimea region and supporting rebellions in the mostly Russian-speaking provinces in eastern Ukraine (17% of 44 million Ukrainians are Russian-speaking). An economic crisis ensued. It improved a little for a while afterwards, but Ukraine’s economic growth has remained relatively low; average real wages have not risen in 12 years and collapsed severely during the 2014 crisis (Figure 1).

Ukraine had been hardest hit by the collapse of the Soviet Union and the “shock therapy” of capitalist restoration in Eastern Europe and Russia itself. All the former Soviet satellites took a long time to recover GDP per capita and income levels; Ukraine never got back to the 1990 level. Ukraine’s economic performance between 1990 and 2017 was not just worse than its European neighbours; it was the fifth-worst in the entire world. Between 1990 and 2017 there were only 18 countries with negative cumulative growth and even in that select group, Ukraine’s performance puts it in the bottom third along with the Democratic Republic of Congo, Burundi, and Yemen. [3]

In the debt and currency crisis of 2014, Ukraine was saved from total meltdown by three things: First, it defaulted on the debt owed to Russia, which Russia is still owed. Second, post-Maidan governments turned to Europe for support and engaged in a series of International Monetary Fund (IMF) bailouts; and third, governments imposed a severe program of austerity in public services and welfare support. Ukraine owes Russia $3bn, or more than 10% of its FX (foreign exchange) reserves; paying this debt would more than double Ukraine’s external financing gap. That gap is being currently filled by IMF funds, while Ukraine “negotiates” with Russia on a “debt restructuring,” supposedly mediated by Germany. So Ukraine, in breaking with Russian influence from 2014, chose to or was forced to rely on the “West” and IMF credit to support its currency and hope for some economic improvement. [4]

IMF handouts continue to this day. The latest is an agreement to extend loans into 2022 worth $699m of a total $5bn IMF “stand-by arrangement.” For this money, Ukraine “must keep its debt ‘sustainable’, safeguard the central bank’s independence, bring inflation back into its target range and tackle corruption.” So austerity measures must be applied to public spending; the central bank must act in the interests of foreign debtors, not allow the currency to devalue too much, keep interest rates up without the interference of the government, and the rampant corruption in government of the Ukrainian oligarchs must be controlled. [5] Austerity measures have been applied by various Ukraine governments over the last ten years. The current IMF package requires a tax increase equivalent to 0.5% of annual GDP, increased pension contributions, and rises in energy tariffs. All these measures will lead to a further fall in welfare spending, from 20% of GDP at the time of the 2014 crisis to just 13% this year (Figure 2). At the same time, the IMF has demanded that the government must resist any public sector wage increase to compensate for near double-digit inflation rates.

Above all, the IMF is demanding, with the support of the latest post-Maidan government, a substantial privatization of the banks and state enterprises in the interests of “efficiency” and to control “corruption.”

The authorities remain committed to downsizing the [state-owned enterprise] SOE sector. Adopting an overarching state ownership policy would be a key step. Ultimately, corporatization and the concomitant improvement in performance of non-strategic SOEs should lead to their successful privatization.… Preparations are also underway to execute the authorities’ strategy to reduce state ownership in the banking sector. Updated in August 2020, the strategy envisions a reduction in state ownership to below 25 percent of banking sector net assets by 2025. [6]

Most significant has been the move to privatise land holdings. Ukraine is home to a quarter of the fertile “black earth” soil (Chernozem) on the planet. It is already the world’s biggest producer of sunflower oil and the fourth-biggest producer of corn. Along with soybeans, sunflowers and corn are among the main crops grown in the Sunflower Belt, stretching from the eastern city of Kharkiv to the Ternopil region in the west. But agro productivity is low. In 2014, Ukraine added $413 agricultural value added per hectare was $413 in Ukraine compared to $1,142 in Poland, $1,507 in Germany, and $2,444 in France. Land is highly polarized between a small workforce in large mechanized commercial farms and the mass of peasants who farm small plots. About 30% of the population still live in rural areas and farming gives employment to more than 14% of the workforce.

One of the great demands of Western advisors to Ukraine in recent years is that it should “liberalize” the land market so that “a prosperous growth dynamic” might be unleashed. The IMF reckons that such liberalization would add 0.6-1.2 percentage points to annual GDP growth, depending on whether the government permitted both foreign and national land ownership. The government is resisting allowing foreigners to buy land. But in 2024, Ukrainian legal entities will qualify for transactions involving up to 10,000 hectares, which will apply to an agricultural area of 42.7 million hectares (103 million acres). That is equivalent to the entire surface area of the state of California, or all of Italy! The World Bank is positively drooling at this opening up of Ukraine’s key industry to capitalist enterprise: “This is without exaggeration a historic event, made possible by the leadership of the President of Ukraine, the will of the parliament and the hard work of the government.” So Ukraine plans to open up its economy even more to capital, particularly foreign capital, in the hope that this will deliver faster growth and prosperity. [7]

But this is hope only. Current annual economic growth is optimistically forecast to rise to a 4% rate each year while inflation will stay at 8-10% a year. Unemployment remains stubbornly high (10%), while business investment is falling off a cliff (down 40%). Even before the war this did not bode well for a capitalist boom in Ukraine. Capital investment is low because the profitability of capital is very low (Figure 3).

Maybe the riches to be gained from the privatization of state assets and land could reap rewards for some capitalists, probably mostly foreign investors. But most of the gains will probably disappear as corruption remains rampant. The IMF admits that if corruption is not reduced, there will be no recovery and Ukraine will not catch up with the rest of its neighbours to the West. Officially, Ukraine’s Gini coefficient, measuring income inequality, is the lowest in Europe. That’s partly because Ukraine is so poor: there is practically no middle class. But the very rich hide their income and wealth, paying little or no taxes. The “shadow economy” is very large, so the top 10% have wealth and income 40 times larger than the poorest Ukrainians. The current World Happiness Report puts Ukraine at 110 out of 149 countries, below many sub-Saharan African countries. [8]

And the conflict with Russia even before this war has cost Ukraine hugely. According to the Center for Economic and Business Research (CEBR), the loss of GDP has been $280bn dollars over six years from 2014 to 2020, or $40bn annually. [9] The Russian “annexation of Crimea has resulted in losses of up to $8.3 billion annually for Ukraine, while the ongoing conflict in the Donbas was costing the Ukrainian economy up to $14.6 billion a year. Total losses from these two occupations alone, since 2014, amount to $102 billion.” The CEBR says “the conflict had a significant impact on the Ukrainian economy, including by reducing investor confidence in the country. This, in turn, led to a loss of $72 billion, or $10.3 billion annually. The steady decline in exports resulted in total losses for Ukraine of up to $162 billion between 2014 and 2020. The total loss of fixed assets for Ukraine in Crimea and Donbas from the destruction or damage of assets amounts to $117 billion. And the total amount of foregone tax revenues to the budget of Ukraine for the period from 2014 to 2020 is $48.5 billion.”

After the fall of the Soviet Union, and after Ukraine gained its official independence in 1991, the people of Ukraine were ravaged by oligarchs who milked the assets and resources of the country, and by corrupt governments swinging their support between Putin’s Russia and the EU. But since the Maidan uprising against the rule of the pro-Russian government, ultra-nationalists (some of whom are outright fascists) have dominated government policy. As a result, the government has banned the teaching of Russian in schools, as well as demanded that Ukraine join the EU and, above all, join NATO in order to regain the territories annexed by Russia (this demand has been written into the constitution).

The cruel irony is that, before the Russian invasion, Germany had no intention of allowing a volatile and very poor Ukraine to join the EU—that would make for far too much trouble and cost. Even the US was baulking at NATO membership. In turn, Russia had no intention of handing back the Russian-speaking areas to Kyiv control and instead was demanding permanent autonomy and an agreement that Ukraine would never join NATO. The so-called Minsk accords of 2014-5, signed by the major powers and by the Ukraine government at the time, aimed to recognise the integrity of the Ukrainian state but also give autonomous rights to the Russian-speaking rebel provinces and pledge that Ukraine would not join NATO without Russian agreement. That accord was never agreed to by the Kyiv nationalists in parliament and, encouraged by the US, they continue to press to join NATO. In reaction, the Russians continued to prepare for a possible invasion to force an agreement to divide the country permanently. Ukraine became trapped between the interests of Western imperialism and Russian crony capitalism.

Eventually, Putin went for the invasion option. But this has now exposed the weakness of the Russian economy. Russia is not an imperialist state in the economic sense. It is a weak capitalist state without military bases around the world, without a major technology base, and without the financial tentacles of the G7 imperialist bloc. Instead, it is a crony-capitalist state, controlled by an autocrat supported by a bunch of billionaire oligarchs. There are many such regimes—Turkey, Saudi Arabia, Egypt, Morocco, Myanmar, Iraq, Syria, etc.—none of which are imperialist in the Marxist sense.

The series of sanctions imposed by the G7 and Europe on Russia’s economy have revealed how weak a capitalist economy Russia is. The first of these sanctions was the suspension of any dealings with several leading Russian banks, including the two largest, Sberbank and VTB. However, it was significant that the sanctions excluded Gazprombank, the major Russian lender to energy export companies. Clearly, the West does not want to disrupt oil and gas exports, when Germany alone imports 40% of its energy from Russia. As a result, the NATO sanctions package has substantial exceptions. Most notably, while it sanctions major Russian financial institutions, it exempts certain transactions with those institutions related to energy and agricultural commodities, which account for nearly two-thirds of total exports. Amusingly, Italy successfully lobbied to exempt the sale of Italian Gucci bags to Russia’s rich from the export ban!

As the Russian invasion continued, the G7 upped the ante. EU leader von der Leyen and Biden in the White House announced that “we will work to prohibit Russian oligarchs from using their financial assets on our markets.” [10] Biden says that the US will “limit the sale of citizenship—so-called golden passports—that let wealthy Russians connected to the Russian government become citizens of our countries and gain access to our financial systems.” [11] The EU and the US were to launch a task force to “identify, hunt down and freeze the assets of sanctioned Russian companies and oligarchs, their yachts, their mansions, and any ill-gotten gains that we can find and freeze.” The irony and hypocrisy of these proposed measures should not be missed. For decades, Western governments have been happy to take this “dirty money” and even allow the oligarchs to gain citizenship and special privileges to exert influence in politics in their countries in order to bolster pro-capitalist parties. Now these privileges are to be withdrawn (although we shall see how far this goes).

Nothing has been done in 30 years to deal with the way the rich hide their gains in offshore tax havens with the help of banks, lawyers, and accountants. Russia’s super-rich (including Putin) have massively increased their wealth during the COVID pandemic. Russia’s billionaires (we like to call them “oligarchs” in the West) have the highest share of wealth to GDP of all the major capitalist economies, closely followed by “social-democratic” Sweden, and then the US (Figure 4).

Like other billionaires, Russia’s export and hide their wealth in tax havens and in obliging Swiss and other banks, and also buy property and assets abroad. Their “offshore” wealth is far higher than that of other billionaire groups (Figure 5).

But the export and trade bans, the suspension of dealings with selected banks, and the withdrawal of some privileges for Russian oligarchs will have little effect on Russia. Energy trade is to continue, with Russia still providing 25-30% of European energy supplies. And Russia is no longer dependent on external financing. Russia’s current account surplus has risen from below 2% of GDP in 2014 to around 9% of GDP in 2021, leaving substantial buffers of excess savings that can be tapped should the need arise. The wider public sector, including the Central Bank of Russia (CBR), the corporate sector, and the financial sector, are net external creditors. The CBR had over $630 billion in reserves, enough to back up three quarters of domestic money supply, so there would be no need to print rubles to fund economic activity. In addition, Russia has a $250bn sovereign wealth fund, which although relatively illiquid, could be run down to bolster funding.

Russian businesses and the government had prepared for potential future shocks like losing access to the dollar,r and their use of the US dollar in trade and financial transactions has already sharply declined. The Ministry of Finance no longer holds any USD-denominated assets in its oil fund and the CBR has also reduced the share of USD in its reserves by half, to around 20%, as the euro, and to a lesser extent the Chinese renminbi, have become preferred alternatives. Many Russian corporations and banks now routinely include clauses in contracts that stipulate the use of another currency for settlement in case the USD can’t be used. Russia has also accelerated the use of its own payment cards, like Mir, as well as its own SWIFT-like System for Transfer of Financial Messages (SPFS) messaging service. However, both currently only operate domestically, leaving vulnerability to cross-border transactions in other currencies.

That’s why the US and European governments decided to introduce much more serious sanctions. They have now kicked Russian banks out of the SWIFT international transactions system and frozen Russian central bank assets. The SWIFT measure will sharply complicate the ability of Russian banks to conduct international activities. They will be forced to use bilateral arrangements with “friendly” banks, or old technology like faxes. But this could also damage banking and trade for Europe, in particular if the Russian energy lender Gazprombank is also removed from SWIFT (not likely).

The most serious measure is the proposal to freeze the dollar assets of the Russian central bank. This has never happened to a G20 member state before. Only Venezuela, North Korea, and Iran’s central banks have suffered this fate. If effective, it would mean that Russian FX reserves in dollars could not be used at all to support the ruble in international FX markets or sustain domestic commercial bank dollar financing. The government would have to rely on ruble financing (and the ruble is plunging in world currency markets) and non-fiat currencies like gold. Most of Russia’s currency FX reserves are held in Western central banks. Russia has about 23% of its reserves in gold, but it is not clear where this is physically held. This could seriously damage monetary flows and the Russian ruble, causing accelerated inflation and even runs on banks. The ruble has already depreciated against the dollar by 30% in a few days (Figure 6).

Then there is foreign investment in Russia’s energy and resources sectors. Already, major Western energy companies like BP and Shell are pulling out of Russia. Most foreign direct investment (FDI) into Russia originates in the European Union: European investors own 55-75% of Russian FDI stock (Figure 7). The EU is the primary investor in Russia. The energy sector (oil and gas) plays a predominant role in the Russian economy and dominates exports. And much of the FDI is really rounding investment by rich Russians who have shifted their money out into tax havens like Cyprus, Ireland, Luxembourg, and Malta. Cypriot subsidiaries in particular hold large amounts of assets for Russian entities, which are occasionally repatriated as FDI. [12]

Then there are the “slow burn” sanctions on Russia’s access to key technologies. The US aims to cut Russia off from global chip supplies. The move shuts off supply from leading US groups such as Intel and Nvidia. Taiwan Semiconductor Manufacturing Company, the world’s largest contract chipmaker, which controls more than half the global market for made-to-order chips, has also pledged full compliance with these new export controls. Russia is now effectively denied access to high-end semiconductors and other tech imports critical to its military advancement. However, it’s possible that Chinese companies, especially those that have themselves been the target of US sanctions, might help Russia circumvent the export controls. Huawei could step in to develop the Russian telecom equipment market. [13]

All in all, Putin’s invasion of Ukraine is a huge gamble, which if it does not succeed in “neutralizing” Ukraine and forcing NATO into an international agreement, will seriously weaken the Russian economy. That’s because Russia is no superpower, economically or politically. Its total wealth (including labor and natural resources) is far down the league compared to the US and the G7 (Figure 8). [14]

The collapse of the Soviet Union in 1990 was followed by Yeltsin and the pro-capitalist government accepting the “shock therapy” policies of Western economists to privatize state assets and dismantle public services and the welfare system. [15] A small elite, mainly former-Soviet government officials, were able to buy massive state assets in energy and minerals on the cheap and through bribery and thuggery. Russia’s oligarchs emerged, along with an increasingly autocratic regime personified by Putin. Russia’s GDP plummeted and average living standards dropped sharply. The Russian capitalist economy eventually recovered with the global commodity price boom after 1998, but by 2014 Russia’s average annual GDP growth was still only one percent.

Life expectancy in capitalist Russia has now been surpassed by China. And when we look at the World Bank’s Human Development Index, which measures key dimensions of human development (a long and healthy life, being knowledgeable and having a decent standard of living), we find that since 1990 Russia has performed worse among major emerging economies and compared to the world average (Figure 9). [16]

The Russian economy is really a “one-trick pony,” relying mostly on energy and natural resources exports. The economy suffers from what economists call the “Dutch disease,” where natural resource export surpluses drive up the currency, worsening terms of trade for other exports, and reducing the competitiveness of other industries. This is what happened prior to 2010, when increases in the price of oil resulted in a gradual appreciation of the ruble, reducing investment in non-fossil fuel sectors (which became increasingly uncompetitive in international markets). But since 2010, the Russian economy has basically stagnated. Although Russia’s economy is larger than it was in 2014 in real terms, final domestic demand is still at its pre-2014 level. And cumulative GDP growth over this period was only positive because exports were seventeen percent higher in real terms in 2019 than in 2014. Russia’s capital stock is still lower in real terms compared to 1990, while the average profitability of that capital remains very low (Figure 10).

The World Bank reckons that the long-term potential real GDP growth rate for Russia is just 1.8% a year—and even that is faster than it has achieved in the last decade. After the annexation of Crimea, the G7 imposed sanctions on Russia. The IMF reckons sanctions reduced GDP growth by about one percent a year. The latest round of sanctions will be much more damaging. Oxford Economics reckons it will knock at least 1 percentage point a year off real GDP growth over the next few years. If that happens, basically Russia will be in economic recession for several years (Figure 11). Russia has a pressing need to diversify its economy away from resource extraction. European investment could provide an engine for the growth of higher value-added sectors and the subsequent boost to the overall economy. The EU could offer diversification and growth opportunities by investing in Russian manufacturing and value chain operations. None of this is going to happen now that Russia has invaded Ukraine.

If Putin can gain control of Ukraine, that will open up significant riches to be exploited. Ukraine is rich in natural resources, particularly in mineral deposits. It possesses the world’s largest reserves of commercial-grade iron ore—30 billion tonnes of ore or around one-fifth of the global total. Ukraine ranks second in terms of known natural gas reserves in Europe, which today remain largely untapped. Ukraine’s mostly flat geography and high-quality soil composition make the country a big regional agricultural player. The country is the world’s fifth-largest exporter of wheat and the world’s largest exporter of seed oils like sunflower and rapeseed. Coal mining, chemicals, mechanical products (aircraft, turbines, locomotives, and tractors), and shipbuilding are also important sectors of the Ukrainian economy. All of this remains to be fully exploited. The EU and the US, as noted, have also been drooling over the prospect of getting hold of these resources. They could deliver massive dividends to whichever power controls the country. Of course, much depends on how the war pans out. Either way, once the war is over and after thousands have been killed or injured, Ukraine’s people will see little of the benefit.

As for the world economy, this war is yet another obstacle to any improvement in the expansion of the major capitalist economies. Even before the COVID pandemic hit, the major capitalist economies were heading into a recession, with economic growth, investment, and profitability of capital (the key driver in capitalist economies) dropping towards zero. [17] Then came the pandemic slump, with millions dead globally from the infection and the major economies losing something between 3 and 5% of potential national output forever; while over a hundred million have been driven into extreme poverty—in a world where up to 4 billion people are already poor by any realistic measure.

Governments and mainstream economists have made much of the recovery in 2021, after vaccinations in the rich countries and the opening-up of economies in order to live (or die) with COVID. But the “sugar burst” of recovery was already starting to fade before the Ukraine war erupted. And accompanying the recovery this time are rocketing energy and food prices. These have accelerated inflation rates in the major economies to levels not seen for over forty years. Wages are not keeping up and households are beginning to suffer a significant drop in living standards. And that’s before the new taxes and cuts in welfare which are to come. And they are coming. All the talk in Western governments is about increased arms and “defense” spending to stop Russian “aggression” and to expand US military hegemony in Europe—and also in Asia, to stop China’s “expansionism.” That means more money for guns and less for butter.

Energy prices have rocketed. But this does not mean that governments will reduce fossil fuel investment and production. On the contrary, supply will be increased to allow Europe in particular to rely less on Russian energy. Saudi and US oil output will rise. Increased military spending will also add to carbon emissions (the military are the biggest single emitters of carbon globally). [18] And this comes just at the time when the IPCC, the international body of climate scientists, have warned that time has run out for trying to meet the Paris global warming targets and that the world’s environment is heading for irreversible damage. [19]

When the Soviet Union collapsed, Yeltsin’s advisers in the West urged a quick transformation to capitalism and the opening of markets and investment to US and European multinationals. But the ailing Yeltsin handed power to an unknown former KGB agent, Putin. Initially, Putin asked for Russia to join NATO and the EU! But he was rebuffed by the G7. So instead, he proceeded to ally himself with a range of Russian billionaires and to follow an independent economic and political strategy for Russia. He aimed to restore Russia’s prestige and hold back the American-led advance into previous Soviet territories.

US imperialism has been in relative decline. Its superiority in technology, trade, and manufacturing has slipped in the wake of rival economies—Europe, then Japan, and China in the twenty-first st century. But it retains its hegemony through its global financial tentacles and massive military power, as Figure 12 shows (compiled by Marxist economist Tony Norfield). [20] Note where Russia is on the chart. The US is using this power to try and squeeze and crush any opposition from the likes of uppity nations like Russia or China. And it is making Europe and Japan follow its lead.

Because Putin has not played ball with American interests, just like Saddam’s Iraq, Assad’s Syria, or Chavez’s Venezuela, the US (with the rather reluctant support of the EU) has strode in to isolate and surround Russia militarily and squeeze its economy. Ukraine has become a pawn in this confrontation between Western imperialism and Russian crony capitalism. It is suffering like all small states in geopolitical confrontations—such is the intertwining of politics and economics.

---

Michael Roberts worked in the City of London as an economist for over 40 years. He has closely observed the machinations of global capitalism from within the dragon’s den. At the same time, he was a political activist in the labor movement for decades. Since retiring, he has written several books. The Great Recession—a Marxist view (2009); The Long Depression (2016); Marx 200: a review of Marx’s economics (2018): and, jointly with Guglielmo Carchedi, edited World in Crisis (2018). He has published numerous papers in academic economic journals and articles in leftist publications. He blogs regularly at thenextrecession.wordpress.com.

Click here to subscribe to ESSF newsletters in English and/or French.