According to Financial Times sources, cash payments, or rather a lack of them, where actually at the heart of why Wagner leader Prigozhin started his march on Moscow. This was seemingly confirmed by the Chechen leader Kadyrov, who publicly accused Prigozhin of putting his business interests before the national interest.

So, why did the Kremlin stop paying mr. Prigozhin as much? Could it be that it ran out of money and that therefore sanctions are starting to break Russia after all?

To answer that question, I’ve been digging through some of the latest research about how the Russian economy is really doing, the damage that sanctions have done to it, and finally, about the role of sanctions in causing this crisis.

So, to see if sanctions are breaking Russia, let’s first dive into

1 How The Russian Economy is Really Doing

Because to see how damaging sanctions have actually been, we first need to ask ourselves: can we actually use official GDP data it to calculate the impact of sanctions? After all, Russia’s GDP figures are reported by… the Russian government. The same government that assured us, not too long ago, that it would not invade Ukraine. The same government that assured us that it had no connections to the Wagner group in 2021.

But, believe it or not, before the 2022 invasion, Russia’s economic statistics were actually considered quite reliable, far more reliable than, for example, Chinese statistics.

Now, I get it, it’s easy to say, phew Joeri that is so naïeve.

But, don’t forget that thousands of researchers used these statistics every day. So, if the Russians were consistently manipulating them. Someone was bound to spot some red flags. And while they did for Chinese data, they just didn’t for Russian data, at least not until the 2022 invasion.

After which, Russian statistical agencies started unpublishing crucial data sets, like electricity consumption and imports, that could tell us something about the impact of sanctions. Russia kept publishing GDP data though. But, naturally, after this, people got suspicious about these as well. Could it be that Russia had started manipulating it’s GDP statistics to hide the true impact of sanctions?

To answer that question, economists and journalists immediately started looking for alternative data that could tell us what is really going on with Russia’s economy.

One promising new approach involves tracking pollution from Russian factory using satellites. Seen from space most Russian industries seemed to have one average declined by 6.2% last year, even though official statistics reported a 1.2% increase in production. This deviation was especially big for the civilian industries like the automotive sector, for which pollution dropped by 16% in 2022, even though official statistics seem to suggest it has been relatively stable.

But, of course, just looking at pollution alone is not a very robust way to see how Russia’s economy is really doing.

Ideally, you’d want to look at much more alternative data and see how these correlated with Russian GDP before the 2022 invasion of Ukraine. And, that is exactly what ECB economists Adrian Schmith and Hanna Sakhno have done when they constructed an alternative tracker for Russia’s economy that doesn’t rely on data provided by Russia’s official statistics agency. Instead, their tracker relies on a variety of different datasets that includes the pollution data mentioned earlier as well as data such as consumer bank card spending statistics, import data from trading partners, house sales data, google searches for unemployment, and more. Interestingly, while their tracker matches official data pretty well before the 2022 invasion, it starts to perform worse than a similar tracker based official data after the invasion, suggesting that Russia’s economy did between 0.2 and 2.9% worse than official statistics would say.

However, while this research is really interesting, to me it didn’t proof without a doubt that Russia is manipulating it’s GDP statistics for two reasons. The first reason is that this is not yet a peer-reviewed scientific study, and to get published, I think, this tracker would also need to be thoroughly tested on other countries as well. After all, this range of 0.2% to 2.9% of GDP is pretty big. The second explanation for the difference between the tracker and official statistics is that the tracker focusses on the civilian economy while Russia’s spending has massively shifted to the military in 2022. At least, that is what author Hanna Sahkno told me when I interviewed her live on this channel,

So, in summary, while there are some big red flags about Russian data, it’s not proven beyond reasonable doubt that official GDP figures are manipulated or that they can be explained by a radical shift to a war economy.

And therefore, when estimating the impact of sanctions, I’ll use the official figures as a baseline for now and recommend that you add between 1 -3% in damages, depending on how skeptical you are of the data.

So, with that out of the way, let’s answer the following question:

2 How much damage have sanctions done to Russia’s economy?

First, let’s get to the bad news. An economist like me can never answer this question with the certainty of a natural scientist.

The reason is that, while natural scientists have their laboratory experiments, economists just don’t have a good counter-factual. After all, a chemists can study the precise impact of adding one Alkali Metal element to water by doing it in a controlled setting, and comparing it the alternative of just looking at .. water. And if chemists do this multiple times, they can state with a lot of confidence that adding alkali metals to water will always cause the chemical reaction that you see here.

However, to tell you with the same confidence the causal impact of sanctions on Russia’s economy, economic scientists would need two realities. Our own reality in which Russia invaded Ukraine, it was sanctioned and in which Russian GDP dropped by 2.1% in 2022, plus a control group reality in which Russia also invades Ukraine, does not get sanctioned, and where GDP increased by 5.9%. Now, if this was possible, an economist could tell you with the confidence of a natural scientist that the impact of sanctions was to reduce Russian GDP by 8%.

However, since such an alternative reality does not exist, economic researchers had to come up with clever, but imperfect, ways to estimate the true impact of sanctions on Russia’s economy. And while none of these estimates is perfect, combining them indicates that sanctions have likely reduced the size of the Russian economy by 7.37%, which is actually quite a lot.

So, how did I get to this number? Well, I did so by reading studies that used three different techniques to estimate the impact of sanctions on Russia’s economy.

And, just to get it out of the way now. All of these techniques have huge flaws, which is not surprising given that … you know… economists don’t have access to the alternate reality in which Russia invaded Ukraine. But, did not get sanctioned.

So, instead, I will just take the average of all of these highly flawed estimates, which, since these flaws are not the same, should give us a more reliable estimate of the true impact of sanctions on Russia’s economy.

Okay, the first, most popular, way economists calculated the likely impact of sanctions on Russia’s economy is by comparing the performance of Russia’s economy to predictions about its performance before the war and before sanctions were imposed. And, given that forecasters were on average expecting Russia’s economy to rebound from the impact of Covid in 2022 with 5-8% growth or so, and the economy contracted by 2.1% in 2022, then the logical implication is that, thanks to sanctions and war, Russia lost between 7-10% of GDP. According to the Bank of Finland, which summarized these types of studies, the average estimate is a drop of 9% in Russian GDP.

Of course, the weaknesses of this approach are that it does not separate the war from the sanctions and that it implicitly assumes that these original predictions were going to be accurate.

So, let’s find some more flawed estimates to get a better picture.

Luckily Bank of Finland researchers also summarized a more scientific way that economists have studied the impact of sanctions on Russia and that is to create a mathematical model of Russia’s economy, and then compare the impact of sanctions in two simulations of that model. On average these studies suggest that Russia’s GDP declined by about 7%. However, while this scientific set-up is great, the big flaw here is of course that these models are gross oversimplifications of the real Russian economy and the sanctions imposed on it.

So, let’s add one more flawed estimation method before we get to our number.

Professor Richard Disney from the university of Sussex has proposed that we estimate the impact of both the war and the sanctions by looking at oil, yes oil. Because Russia’s economy is extremely reliant on energy prices, which are closely linked to the oil price, it’s entire economic performance used to be heavily correlated with oil prices. If oil was expensive, Russia grew fast, and if it was cheap, Russia grew slowly. Leveraging this correlation, professor Disney calculated that if oil prices had roughly continued as they did before the invasion a 4% growth rate is a rough estimate of where Russia’s GDP growth could have been in 2022. However, considering the reported negative growth rate of around -2.1% in 2022, this simple calculation suggests that the war and sanctions lead to a minimum GDP cost of 6.1%.

So, if we combine these estimates, the best estimate we can get for the impact of sanctions on Russia’s economy in 2022 is: minus 7.37%. Or, perhaps minus 8.37 or even minus 10.37% if you don’t trust official Russian GDP numbers, or want to potentially correct for the influence of Russia’s war spending.

However, given that these estimates are so flawed, I just want to stress again that this estimate is to be taken with a gigantic grain of salt. After all, unlike natural scientists, us macro economists are still stuck with bad data and the fact that there is no counter-factual.

Still, I still think this exercise of producing a number is useful because it show us that, even though Russia’s economy did better than initially expected, Russia’s economy should have grown by quite a lot after the Covid pandemic, and instead it contracted. So, I think we can safely say that sanctions were actually quite damaging.

And that can explain why, after oil prices came back down, Russia’s government is now reportedly in more and more trouble to keep paying its bills. And given that Putin recently admitted that they paid Wagner roughly a Billion dollars per month

<show clip of Putin saying this>

The impact of sanctions could potentially explain that they wanted to cut costs by paying Wagner less.


Did sanctions break Russia after all?

Well, it could be, eager to avoid borrowing more, the Russian state has recently been trying to raise extra money from the big companies run by its famous oligarchs.

And, so it could very well be that mr. Prigozhin and his Wagner group were one of these companies which the state is trying to squeeze for money.

So, yes, given the limited information that we have, it could be that sanctions are increasingly starting to play a role in the current chaos that we are seeing in Russia.

That being said, I have seen other plausible explanations from political scientists, as there is rich history of examples where poor war performance led to internal conflict. For example, it could very well be that the Russian defense ministry has been reducing Wagner payments because it felt threatened by their increased prominence. This would make sense, given that it also tried to bring it, and other militias, under increased control with new contract.

And, this I think shows us a final flaw in the science of macroeconomics, it cannot hope to explain global affairs, without political context. Still, I hope that this analysis given you an interesting alternative perspective on the Wagner uprising.

What do you think? Was it mostly sanctions, the faltering war effort, politics, or a combination of all of these? Let me know in the comments below.