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  • Pavel Kohout

Putin's War

The war against Ukraine began long before the "peacekeeping mission" in support of the Russian-backed pseudo-state formations with bizarre names in eastern Ukraine. The mere threat of invasion and a civil war in the east of the country has had effects comparable to a regular military conflict: it has consummed significant financial resources, has made Ukraine's national debt more expensive, and has thoroughly deterred potential foreign investors.



Of course, all this did not start in the last few days or weeks. Prior to 2014, Ukraine was spending around 1.6 per cent of its gross domestic product on defence annually. That is an amount comparable to, for example, Italy. It would correspond to the situation of a country that is not in acute military danger and does not want to pose a similar danger to neighbouring countries. In addition, the Ukrainian economy has been relatively weak, so that overall military expenditure has been rather modest even in absolute terms.


In 2014, everything has changed. Russia's invasion, annexation of Crimea and installation of two satellite pseudo-state formations in the East of the country marked a rude awakening for Kiev. Since then, defence spending has typically exceeded 3 per cent of GDP, and in 2020 as much as 4.13 per cent.


By contrast, Russian military spending has not fallen below 3 per cent of GDP since Putin came to power, with a peak in 2016 at 5.43 per cent of GDP. The latest figure (2020) speaks of 4.26 per cent. It should be noted here that this is a lower estimate as the officially reported arms spending of the Russian Federation is likely to be lower than the actual.


Of course, the additional funds that Ukraine has been forced to spend on the military since 2014 could be used for more productive purposes: for building much-needed infrastructure, education, health care, etc. This burden on the neck alone is damaging the country's economy.


Then there is the cost of the national debt. It is over 60 per cent of GDP (or 54 per cent, according to other sources). Before 2014, the debt was around 40 per cent of GDP (or maybe less than 30 per cent). That 60 per cent still looks acceptable, but we must keep in mind that Ukraine has not the privilege of paying the First World interest rates.


The base rate set by the National Bank of Ukraine is 10 per cent. (Before 2014, it was 7 per cent; the maximum of 30 per cent was reached in 2015.) The yield on a three-year bond is 16 per cent a year; a 10-year bond carries something around 22 per cent – in theory.


Why in theory? Because the Ukrainian financial market is so illiquid that the market yield of the bond has to be estimated rather than simply observed. The financial market, too, has become a victim of Russia's hybrid war – and it is not an insignificant victim. A dysfunctional financial market has serious implications for economic strength and stability and for the ability to wage war, as hundreds of years of experience testify. The Soviet Union, after all, lost the Cold War, among other things, because of a dysfunctional (or rather non-existent) financial market.


Moreover, political stability and a functioning financial markets are two basic prerequisites for foreign investors to enter a country. Ukraine desperately lacks foreign investment. To be fair, it should be noted here that Ukraine is largely to blame for this, as the critical era of the 1990s was squandered by its oligarchs in the division of the remnants of state property and inter-clan disputes. At a time when the Czechs, Poles, Hungarians and Romanians were reforming their economies and trying to attract international capital, Ukraine's powerbrokers were behaving like a horde of raiders on conquered territory. The consequences of that infamous period last to this day.


But let's leave the past in the past. International investors always make their decisions based on elementary political stability (which is a problem) and on a country's risk premium derived from government bond yields on the financial market (which is also a problem). Moreover, Moscow can effectively and virtually indefinitely keep Ukraine unstable, effectively reducing its economic growth potential. This type of economic hybrid warfare is hard to defend against. The insecurity can last as long as Putin wishes – and as is evident after February 21, 2022, Putin can escalate the intensity of the war at will.


The implication may be that the Russian president is something of a James Bond evil genius. But Putin is no genius. Virtually all the ills of the Ukrainian economy afflict Russia as well, albeit to a lesser degree. Putin has had over twenty years to give the Russian economy a legal basis, a serious financial market, to build a favourable business environment and to take advantage of his country's advantages: in particular, a still good education system and a technically educated population. The result? Absolutely pathetic. Putin has wasted his time. Without oil, gas and other raw materials, Russia's economy would be in even worse shape than Ukraine's.


Russia is failing to export both traditional products (e.g. cars) and high-tech products; compare its situation with China, which has made huge progress since 2000. In 2000, when Putin came to power, Russia had a GDP per capita 84 per cent higher than China. Twenty years later, the two countries' per capita economic performance has levelled off. While China was building, investing, researching and developing, Putin was playing war games and dreaming of restoring the Empire's past glory. Which strategy worked better is clear from the chart below the article.


Russia's best-known export commodity is now international instability. But in doing so, Russia is harming itself. Can anyone really think this is a brilliant strategy?


Gross National Income in current dollars: USA, China and Russia



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