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If I asked you who the biggest
domestic threat to Putin is right now,
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whom would you choose?
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Military aged males—
those currently
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fighting in Ukraine and those who could
possibly find themselves there one day?
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The working class—
those who are avoiding the war
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but instead are grinding away
for their monthly paycheck?
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Oligarchs—those at the top of
Russia’s economic food chain?
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Or pensioners—those retired
and living on fixed incomes?
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Military, working class, oligarchs,
or pensioners. Take your pick.
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Well, if you listen to the mass media takes on
the situation, you are liable to hear about the
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horrors of the war and perhaps default
to military aged males as your answer.
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And that is a reasonable choice
on the surface. After all,
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they are the ones with the guns, and they
are the ones at risk of dying in the war.
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Yet, perversely, they are one of the
two primary beneficiaries of the war
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at the moment. But that position will not last
forever. And when the war eventually ends,
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they are not going to just go
back to their average lives.
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Rather, they and their working-class comrades
will be facing a world of economic pain. And
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that is when those two groups collectively
will start to be a threat to the Kremlin.
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And that is giving Putin a reason to not pull
Russia out of the war regardless of the outcome,
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never mind those that Ukraine hopes to implement.
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So, today, let’s talk about all
four of these groups individually,
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before pivoting to the Kremlin’s
inevitable post war problems.
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We should start with who is actually paying
the costs of the war right now in Russia,
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and why it is not the soldiers.
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Usually, you would start looking at the cemeteries
and say that those losing the most are obviously
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those who are losing their lives. And
that is still true conditional on death.
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However, for about two years now, Russia has been
restocking its forces via volunteer contracts,
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meaning that those who are taking the
risk are choosing to do so because of
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the wage that the Kremlin is offering them.
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As a result, the only people heading
to war right now are those that are
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happy with the financial packages being
offered to them or to their families.
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And they are making quite a bit to be sure. Such
is the nature when you are risking life and limb.
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Indeed, it is called a
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“risk premium” in labor economics, and you usually
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see it in less extreme circumstances
like employment on off-shore oil rigs.
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Deployment to Ukraine is just
an extreme application of the
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idea. Of course, there is some variance here.
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Role a five and die, and you would
regret your decision after the fact.
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Role a four and live some more,
though, and you make a killing.
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The thing is, though, the unlucky ones are
not exactly around to raise any complaints
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afterward. You might have some angry
mothers and wives who could cause a stir,
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but even then death benefits hedge
against exactly that sort of thing.
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And, to be clear, the general principles of
such a system tend to be the best way to build
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an army. Market wages for the job ensure that
only those that want to fight do the fighting.
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It is one of the main reasons
why the United States switched
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to an all-volunteer force decades ago.
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The point is that these people are not
liable to cause a stir in Moscow at the
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moment. Not unless there is a return
to the September 2022-era involuntary
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mobilization or a meta-belief
that this something like this
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might happen again, causing this cohort
to preemptively rise up against Russia.
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So when you hear people talking about the
divide in recruitment rates creating some
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sort of regional tensions—say, between
Siberia and Moscow or Saint Petersburg…
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Well, no, that is not quite accurate. Actually,
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it is very much the opposite. Siberia is doing
well precisely because of those contracts.
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Again, it was different under
involuntary mobilization,
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when the metro elites were skirting their
military obligations to the detriment of others.
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But the Kremlin has moved as far
away from that policy as possible,
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indeed because of the concerns that
popped up with it the last time.
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Now, there are other ways that this group
could still present problems. For example,
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if suddenly they were to stop getting paid,
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then that breaks the social contract
that underlies the voluntary army,
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and we are back to thinking
about a march on Moscow.
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To wit, there was a whole exchange during
Putin’s end of the year roundtable,
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where a questioner pointed out that those
involved in the defense of Kursk were not
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receiving the same benefits as those fighting
in Ukraine. Putin said he was unaware of that,
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apologized, and promised to fix it immediately.
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Likewise, if the voluntary soldiers start to
see their contracts involuntarily renewed—and
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there seem to be some cases like that—then
we are basically back to where we started.
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And part of the motivation for
Ukraine’s Kursk offensive was
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to draw more groups into the war—specifically,
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the national guard, who would
not be there voluntarily.
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That is part of the reason North Korean
soldiers have entered the fray there.
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But the point is that they are not the ones
the Kremlin worries about. For now anyway.
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We will get back to them in a minute.
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Connected to the military
group is the satisfaction of
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basically everyone of working age in the country.
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Two things are driving this. First, after the
Ministry of Defense contracted so many soldiers,
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newfound competition arose in the labor sector.
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With risk-acceptant citizens
departing for Ukraine,
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fewer people remain to work regular jobs.
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Consequently, employers have
raised wages to stay competitive.
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And it gets even better for the workers:
materiel needs are also forcing the Ministry
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of Defense to pay for tank factories, ammunition
factories, and the like to run round the clock.
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That further increases labor
demands within the country,
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yet further shooting up wages and also
leading to record low unemployment.
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In turn, this may be the best time to be a
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member of the working class in the
history of the Russian Federation.
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Now, you may be thinking to yourself:
isn’t there massive inflation inside of
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Russia? And isn’t that eating
into all of those wage gains?
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Well, yes and yes. All of that is correct.
Working class people are disproportionately
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affected by inflation because almost all
of their paychecks is immediately consumed.
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But here is the thing: wage growth is outpacing
inflation by quite a bit. As a result,
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those individuals are experiencing real wage
increases. And indeed, this was a major topic
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of discussion during that same end of the year
roundtable that we discussed a moment ago.
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Actually, to be clear about the causal
direction here, Ministry of Defense contracts
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pulling people out of traditional production jobs
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is the entire reason why inflation is
happening in Russia in the first place.
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Less stuff being produced,
more money chasing the products,
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what do you get?
Inflation.
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Put differently, without inflation,
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the working class would not be
experiencing the wage growth that it is.
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Someone has to be losing in all of this, of
course, and we can start with the oligarchs.
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Now, lines on maps-a-maniacs
are enlightened bunch.
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And based on this super unscientific
poll of viewers, I may be preaching
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to the choir here.
But here goes anyway.
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It would be tempting to look at
the Russian economy, note that
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annual GDP growth has been between
three and four percent over the last two years,
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and conclude that everything
must be going great for everyone.
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But then you take a closer
look at the formula for GDP,
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realize that government spending
is a large percentage of it,
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and then start to wonder where
all of the money is coming from.
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Indeed, when you are paying market
prices to fund your military,
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someone has to foot the bill for all of it.
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The oligarchs, as the group that
bears the disproportionate burden
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on the implicit tax base, are the ones to suffer.
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Or at least some of them, anyway. Those who are
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involved in the military-industrial
complex are sitting pretty right now.
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But the rest of them … yikes.
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Part of this has already been borne
out. When the Kremlin created the
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“Fortress Russia” national
savings plan a decade ago,
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the country overpaid taxes for the
purpose of creating a budget surplus.
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Fast forward to today, and Russia is
now running massive budget deficits.
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The solution is a combination of
drawing down the Fortress Russia funds
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and to increase present tax burdens—something
that falls disproportionately on the oligarchs.
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It is difficult to adjust to this mindset, but
there are important implications once you do.
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When we see eye-popping
casualty figures like these,
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it is easy to default to thinking
that this is going to result in anger
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from the potential soldier pool.
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But because Russia has been
operating under volunteer contracts,
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what this really does is raise
wage demands for two reasons.
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One, Russia will need to keep recruiting. Now, the
people most willing to go to Ukraine have already
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left. Thus, the supply is constrained,
and wages need to go up accordingly.
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Two, expectations about the risk of death
or dismemberment increase. As such, that
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“risk premium” from earlier will need
to increase as well to compensate.
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All told, this places higher tax burdens
on the oligarchs. And, crazy enough,
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the working class does even better because
of the heightened wage competition.
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Meanwhile, the oligarchs have also been
harmed in a couple of more subtle ways.
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First, the oligarchs disproportionately
enjoy imported goods from Western countries.
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Sanctions obviously limit what is
available in that regard. And insofar
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as Russians can figure out a way
to get around those sanctions,
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the dwindling value of the ruble has put a
significant hit on their purchasing power abroad.
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Second, they have also lost
access to their Western markets.
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For example, a company like Gasprom
has far fewer countries to sell gas to,
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and thus the price of Russian gas has a
discount on it compared to conflict-free gas.
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Thus, one way to think about the war is as largest
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wealth transfer from oligarchs
to the working class in Russia
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since the rise of the Soviet Union.
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Now, how much of a threat the oligarch class
poses to Putin depends on how easily they can
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coordinate a coup to replace him. And the fact
that he shifted most of the burdens to them
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indicate that is no easy task, as a notable
political entrepreneur discovered in the
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summer of 2023. But at least they
actually have a grievance right now,
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as opposed to the working class.
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The other group worth mentioning
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are pensioners—basically retired
people living on fixed incomes.
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Inflation is absolutely burning them right
now. For example, if your pension was
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20,000 rubles per month,
and inflation jumps 10%,
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then suddenly you are not buying as much stuff.
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That is how we end up with press conference after
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press conference that somehow manages
to shoehorn a mention of egg prices.
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Now, there is a simple step that the Kremlin can
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take to mitigate this problem:
push up the pensions payouts.
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And, indeed, something like
that is always in the works.
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But there is no such thing as a free
lunch. Basic tax increases just shift
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the problem back to the oligarchs. Perhaps
a more sensible solution is to raise money
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through pension taxes on income, which
would effectively redistribute some of
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the windfall profits from the
working class to pensioners.
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In any case, insofar as pensioners
are threats to take to the streets,
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they too present a current threat to the Kremlin.
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And before you think that sounds crazy,
the last time that Moscow was covered in
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protestors was indeed due to proposed pension
cuts—though that also had the support of the
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working class, who believed they would
eventually suffer from the new policy.
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However, all of that is prologue
for the main topic for today:
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the political risks that the
Kremlin faces after the war ends.
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And to understand those, what we really
need to discuss is what will happen to
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the Russian economy in short order following
the conclusion of major combat operations.
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Overnight, the Ministry of Defense contracts
will disappear from the labor market.
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Simultaneously, the factories working
around the clock to produce tanks,
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armored vehicles, and the like
will slow to a crawl. To be clear,
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they will not stop entirely—Russia will still
need to play catch-up to restock its empty
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warehouse spaces—but they will operate
at a fraction of the current capacity.
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This will flood the labor market,
causing workers’ wages to plummet.
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A dilemma will arise at the Russian Central Bank.
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Interest rates sit at twenty-something
percent, as a means to curb inflation—
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people are less inclined to spend when leaving
their money in the bank generates a good return.
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That pulls cash out of the economy
and helps to stabilize prices.
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The major drawback here is that high interest
rates discourage investment—few entrepreneurs
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want to create new businesses or expand existing
ones when loans will saddle them in extreme debt.
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As a result, the only economic growth that Russia
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has experienced over the last three
years is in the military sector,
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and only because the Ministry of
Defense was throwing so much money
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that way that it was possible to
overcome the high interest rates.
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In turn, the number of factories that exist
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to serve the civilian economy is
a fraction of what it should be.
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There has also been a general underinvestment
in productive infrastructure—things like trains
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and shipyards, which weighs down
growth rates in less obvious ways.
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Think about what this means for the
post-war economy. Creating slack in
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the labor market does not fully
solve Russia’s supply problems.
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Once wages plunge, those existing factories
will find running additional shifts to be
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more profitable. So production
will increase a small amount.
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More oversized bottle openers for everyone?
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Whatever that thing is,
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the owners of those factories will enjoy massive
windfall profits—prices will remain high,
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but the cost of production will fall off
of a cliff thanks to the lower labor costs.
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A rise in imports will help to some degree,
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but many countries will be slow
to reopen trade with Russia,
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and the ruble’s cratered value will make
their prices seem prohibitively high.
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So what do you get?
A handful of happy oligarchs,
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and an angry working class that has
felt the rug pulled out from under them,
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now making lower wages but
still facing high prices.
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And still pity the pensioners
for that last reason.
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Now, this problem will not go away until the
Russian Central Bank cuts interest rates.
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Doing so will encourage the
construction of new factories,
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which can in turn make a real dent
in the constrained supply problem.
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The tradeoff there is that
inflation will skyrocket in
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the short term. It will take a while
for those factories to come online.
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And in the meantime, there is not
much incentive to save rubles,
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all while problems with
constrained supply persist.
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So, more money chasing the same small
quantity of goods. What do you get? Inflation!
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And thus there is a recipe for domestic disaster:
a group facing significant economic hardship,
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a large portion of which recently became
masters in how to use lethal force,
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and concentrated in areas that are not
traditionally a part of the political elite.
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That is a lot of tinder capable of creating a much
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larger fire—ironic given that we are
mostly talking about Siberia here.
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Oh, and we should add the
Caucuses to the list as well.
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Anyway, those concerns make convincing Russia
to end the war that much more difficult.
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The Kremlin cannot just leave the conflict—
even under a favorable outcome in terms
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of where the lines on maps fall—
and not worry about the consequences.
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Of course, that is not exactly a good reason to
prolong the war either. The more time that Russia
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spends in Ukraine, the more that the economy
is distorted to provide for the war effort,
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and the more that the conventional economy decays
in the absence of long-necessary investments.
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But the trick for the Kremlin is navigating
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through those problems without losing
hold over the government. To be clear,
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a shock in the balance of power between
two political factions does not imply
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that a civil war will follow.
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Once coercive power swings in the periphery’s
favor following Russia’s withdrawal from Ukraine,
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the onus is on the Kremlin to redistribute
political benefits in line with that new balance.
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The costs of conflict to both
sides ensure that finding a
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solution would be mutually
preferable to a civil war.
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However, that does mean that the
Russian Federation of the late
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2020s will look a lot different
than at the start of the decade.
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It might not reach the levels of reform
following Russia’s defeat in the Crimean War,
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which led Tsar Alexander II
to abolish serfdom within the
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empire. But the government
will have to do something.
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What exactly will this chaos consist of?
00:19:07
Well, the short-run problem is that the
working class will be taking a hit to its
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income while simultaneously inflation will spike.
00:19:16
Therefore, the solution is economic
concessions to that group—effectively,
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government-sponsored handouts.
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But that comes with two side effects.
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The straightforward one is that
the money must come from somewhere,
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which means soaking the oligarchs
once again—though they may be in
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a more giving mood with the end of the
war bringing them some economic relief.
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Also, the entire reason that Russia shifted away
from mobilization announcements like this one
00:19:45
is because the Kremlin believes that there is
more political slack within the oligarch class.
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However, the more pernicious
effect is that the purported
00:19:54
solution actually exacerbates the
original issue to some degree.
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Remember: inflation is half of the problem
facing the working class in the post-war economy.
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But if you give a bunch of
people a ton of free money,
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what do you think happens next?
You guessed it: inflation.
00:20:13
So every ruble that you hand out
immediately undermines a portion
00:20:17
of its own value. Consequently, the government
must overshoot its target just to stay level.
00:20:25
The governor of the Russian
Central Bank Elvira Nabiullina
00:20:28
often ranks among the top of her
peers across central banks worldwide.
00:20:33
She is quietly one of the reasons that the Russian
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economy has weathered Western
sanctions for as long as it has.
00:20:41
But it seems that the end of the war
will be far from the end of her problems.
00:20:46
Meanwhile, the end of the war will be
far from the end of the lines on maps.
00:20:51
But may I suggest a couple of
books to tide you over until then?
00:20:55
Check the video description for
more information about them.
00:20:59
And if you enjoyed this video, please like,
00:21:02
share, and subscribe, and I will
see you next time. Take care.
