## Sunday, March 20, 2022

### Economic stress in Russia

by Ajay Shah.

The Russian economy has faced a series of adverse shocks after the invasion of Ukraine:

• Many de facto restrictions have emerged upon international trade,
• Many foreign companies have chosen to pull out or restrict activities in Russia, spanning non-financial and financial firms,
• Many individuals living in Russia have chosen to emigrate; these are likely to be high skill people.

We may think it is not hard for Russia to absorb these shocks. After all until 1991 it was the USSR, a land of central planning and autarky. We think they will just go back to those ways. However, the recent events are likely to impose substantial costs for the Russian economy.

### Russia is no longer a centrally planned economy

It sounds funny, in today's world, to think of officials owning a target for exports, to think of officials making calculations about how much steel will be required in the light of what the five-year plan has envisaged for building railway lines. But that non-market mechanism for thinking and allocating resources did exist in the USSR (as it did in India).

That institutional capacity has been lost after 1991, and it cannot be quickly recreated. Now, Russia is a capitalist economy. The shocks will be dealt with by the price system in its usual ways.

### Disruptions in the price system

Within the domain of the price system, trade and FDI have a deep influence upon the structure of production. Every modern economy involves millions of decisions about what to produce and how to produce. These decisions are made in a decentralised way, and millions of contracts are in place that govern the purchases and sales of each firm.

When 10% or 30% of these relationships are disrupted, it adds up to a storm in the economy. Yes, production can be reconfigured in a self-reliant way (and self-reliance will always induce greater poverty), but that takes time. There is a period of extremely volatile prices, of shortages, where every firm is cautiously waiting for the dust to settle before establishing a new set of self-reliant contracts. Millions of negotiations have to take place, to get a new set of production relationships going. There is a learning process where some contracts fall into place, and then prices change, and then once again some contracts are disrupted or renegotiated, and so on.

When the price system is humming, it is a marvel to behold, and when it is disrupted, getting back to normalcy (even the low level normalcy of self-reliance) is hard.

In the case of Russia, foreign goods and foreign technology are particularly important. They are an economy organised around selling natural resources and importing everything else. Hence, cutting off ties to the rest of the world will be particularly painful. Russia is more like Saudi Arabia and less like India in this regard.

### Finance is the brain of the economy

Every real sector decision is shaped by finance. To get to the correct decisions in the real sector, we need finance to be operating correctly.

Russian finance is not operating correctly. The Moscow stock exchange was closed down on 25 February. For a month, the economy has not known stock prices. It is difficult for managers to make real sector decisions without the direction that stock prices provide. Conversely, the lack of observation of stock prices induces private decision makers to wait and see.