We’ve never seen a country go backwards as quickly as Russia

One evening in September 2009, Sergei Magnitsky, a corporate tax accountant, was rotting in a Russian jail cell for the Putin government’s fraudulent case against him. Magnitsky had exposed a massive theft and money laundering operation pointing to tax officials at some of the highest levels in the Kremlin. After being held 11 months without trial, Sergei Magnitsky died in jail. An investigator believed his death was premeditated murder. Magnitsky’s employer, Bill Browder – a U.S.-UK financier involved with a major Russian portfolio – has since documented that Sergei was indeed beaten to death by eight police officers.

At the same time, Vladimir Putin was delivering a speech on the importance of private enterprise and foreign direct investment (FDI). Later, Putin said that privatization must be “fair and honest,” going out of his way to praise the private sector and promising to reduce state intervention.

Needless to say, most foreign investors prefer countries where their employees are safe. These events underscore a Russian economic backslide – one which began long before Putin’s invasion of Ukraine – and signal worse to come.

Putin knows (as does his central bank chief) that economic growth is tightly linked to productivity growth. Productivity growth comes mostly from the private sector. For countries like Russia, far from the technology frontier, access to goods, services, people and ideas from other countries is an important lifeline. FDI is a key part of that lifeline. Today, Russia risks losing much of the foreign investment the country has attracted over the years.

Nearly 1,000 companies have already curtailed operations in Russia. Economic and financial sanctions make it costly to do business there for risk of getting caught up in legal problems. There is also the reputational risk. A spokesman for Goldman Sachs said the investment banking company is winding down business operations “in compliance with regulatory and licensing requirements.” French luxury giant Chanel has shut its Russian stores, citing the need to comply with EU sanctions banning the sale of luxury goods in Russia priced over €300, or $312. A classic Chanel medium flap bag is over $8,000. Some rich Russian women are tearing up their Chanel. Meanwhile, mothers in Ukraine are being forced to uproot their families and flee the country they love.

As for the Russian economy, even before the war, it wasn’t thriving. “Russia doesn’t make anything,” President Obama stated back in 2014. “Immigrants aren’t rushing to Moscow in search of opportunity. The life expectancy of the Russian male is around 60 years old. The population is shrinking.” A 2019 RAND report explains Russia’s shocking deterioration in detail.

As relations with the West freeze over, a complete trade embargo appears increasingly likely. Recent estimates show no readily available domestic substitution for high-tech intermediate inputs that Russian manufacturers need. For instance, imported semiconductor chips are necessary for industrial equipment, motor controls, switches, cars and hundreds of other consumer goods. But it is the curtailing of FDI by companies headquartered in allied countries that will hurt the most. Russia attracted an annual average of $24.1 billion in FDI from 2015 to 2019. That was down from the pre-Crimea annexation annual average of $36.3 billion from 2010 to 2014.

Coauthors and I estimate that an allied trade embargo against Russia would decrease its real GDP by an estimated 15 percent to 20 percent, and a big chunk of that impact (85 percent to be precise) is driven by FDI suspension or withdrawal. It turns out that curtailing allied FDI is a powerful sanction tool, inflicting colossal damage to the Russian economy at little net economic cost to allied and non-allied economies. Allied governments looking for more efficient sanctions should take note.

Speaking about the Russian economy in the face of sanctions, Russian Central Bank Governor Elvira Nabiullina noted how output would decline and inflation would exceed expectations. Grasping for a silver lining, she reportedly said the situation would “create opportunities for Russian businesses that previously couldn’t compete with imports.” And speaking at the State Duma recently, she reportedly called for new business models and said the Russian economy will enter a period of structural transformation.

In a recent op-ed in Kommersant, a Russian political and business newspaper, a prominent Russian CEO calls for embracing import substitution. There’s just one problem: To make things domestically, you still need access to the global marketplace. The author asks what kind of autarky Russia needs. Economic logic would lead one to answer “none.”

There is an undertone of panic in these comments. Understandably. While the word “globalization” doesn’t hold the same positive sway it did in the West a decade ago, no one faces involuntary self-sufficiency to the extent Russia may confront.

We have never seen a country go backwards as fast as it looks like Russia will.

Christine McDaniel is a senior research fellow with the Mercatus Center at George Mason University.

Tags Bill Browder Magnitsky Act Russia-Ukraine war Russian economy russian invasion of ukraine Sergei Sergei Magnitsky Sergei Magnitsky Vladimir Putin Vladimir Putin

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