Putin’s War Is Crippling Ukraine’s Economy—and Russia’s, Too

When a large country attacks a smaller, poorer one—with about a quarter its population and one-ninth its economic output—it’s not unreasonable to expect some manageable financial strain for the aggressor and catastrophic devastation for the victim. A year into Russia’s war in Ukraine, the economic fallout could indeed be described in those terms: Much of Ukraine has been reduced to rubble, with millions of citizens huddled in the cold and dark, while life in Russia, if you’re not a soldier on the front lines, remains fairly comfortable.

But as the war enters its second year, it’s becoming clear that the cost to both sides will turn out to be intolerably high. There’s no outcome that looks good for anybody, and the longer the conflict lasts, the higher the economic toll will climb.

Russia’s onslaught has obviously crippled Ukraine, and it’s unclear what it will take for the country to recover in our lifetime. Gross domestic product fell more than 30% in 2022, the steepest decline since Ukraine gained independence three decades ago. Last year’s budget deficit of almost 27% of GDP was plugged with foreign aid and debt that will almost certainly have to be restructured. Inflation officially hit 20%, but in reality it likely exceeded 30%. For poorer Ukrainians, it surely felt even worse. Prices for vegetables, for instance, have risen 85% as Kherson, the country’s biggest vegetable producer, has been the scene of heavy fighting, and much of the region remains occupied.

National Bank of Ukraine has imposed strict capital controls and a fixed exchange rate. In July it devalued the hryvnia by 25%, to 36.6 per dollar, but on the street the rate is closer to 43. Salaries are barely growing, and no wonder: The Warsaw-based Centre for Eastern Studies says the unemployment rate is probably about 40%. The forced emigration of millions of Ukrainians, mostly women and children, and the universal mobilization of men age 18 to 60 have moderated the social pressure. Both, however, pose risks. Refugees settling into new lives overseas and mounting military losses—which Ukraine doesn’t disclose—will sap the potential workforce.

The fighting has taken a particular toll on the most important sectors of the economy. Heavy industry is concentrated in the east and south, where Russia has made the biggest gains and caused the greatest devastation. A September survey of infrastructure loss by the Kyiv School of Economics (KSE) put the damage to roads, bridges, homes, schools, hospitals and arable land at $127 billion. The KSE estimates the destruction of just the physical assets of Ukrainian businesses at $13 billion, while indirect damage, such as lost markets or distribution channels, exceeds $33 billion. Agriculture was strongest in areas of the fertile south that have seen intense fighting; the wheat harvest dropped from 32.5 million tons in 2021 to 26.6 million tons last year—and a quarter of that went to Russian occupiers.

KSE’s damage assessment survey, funded by allied governments, bears the optimistic name “Russia Will Pay.” But it’s unclear whether nuclear Russia will ever cough up reparations, even in defeat. And any payments from the country’s reserves frozen in Western countries are legally complicated: Such a scheme—even a cautious approach recently proposed by the European Commission—would create a dangerous precedent for the global financial system.

The physical damage is compounded by Ukraine’s deep corruption, which remains entrenched even as the war has rendered theft of public funds that much more morally reprehensible than it is in peacetime. of procurement, customs and infrastructure officials have increased in recent weeks as President Volodymyr Zelenskiy tries to keep Western donors on board.

What about the economic consequences for Russia? The country’s GDP dropped only 3% in 2022, according to the Bloomberg consensus estimate. Inflation, at 13.8%, was high but not dramatically worse than in some Western nations. At 2% of GDP, last year’s budget deficit was manageable despite curbs on foreign debt issuance due to Western sanctions. And the official unemployment rate even went down, to 4%, from 4.8% last year, according to the Bloomberg consensus estimate.

Those numbers are misleading, though, and not just because official statistics likely paint too rosy a picture as the Kremlin seeks to prove its resistance, resilience and self-reliance in the face of Western sanctions. Before the war, Russia’s economy was expected to grow at least 3% as it reopened after the pandemic, so the total decline in real production is closer to 6% of 2021 GDP of $1.8 trillion. In absolute terms, that’s $108 billion—about half of Ukraine’s 2021 GDP—meaning the drop in Russia’s economic output tops Ukraine’s.

Russia’s economic losses also look deceptively small because the sanctions it faces, while unprecedented in their scale, have been imposed gradually. Early in the invasion, the country benefited when energy prices climbed as a result of the war. In recent months, the effects of more energy embargoes and a price ceiling on Russian crude have kicked in. The price differential between Brent crude, the traditional benchmark for oil in Europe, and the Russian Urals variety has widened. Russia’s Ministry of Finance says the Urals price has fallen 42% in the past 12 months. For most of last year, oil and gas revenue bolstered Russia’s federal budget by about 1 trillion rubles ($13.4 billion) per month. In November and December, that contribution declined to roughly 900 billion rubles. In January, it was 425 billion rubles.

Even as oil and gas revenue dwindles, the military and security establishment is getting hungrier. Federal defense spending increased 23% in 2022, to more than $66 billion, and it’s slated to expand an additional 6% this year. At current levels, the Kremlin will give the military almost everything it gets from energy sales. That doesn’t augur well for ordinary Russians, especially the half who work in the state sector.

As in Ukraine, the economic outlook in Russia is further dimmed by military losses. Verifiable deaths number more than 10,000, but the total number of dead and wounded is surely far greater—maybe 20 times as high, according to some Western estimates. And, like Ukraine, Russia is plagued by growing emigration, often of highly trained tech professionals fleeing mobilization. Estimates of this outflow vary wildly, but conservative appraisals put it at about 500,000 since the start of the invasion.

The Bloomberg consensus on Russia’s GDP in 2023 is zero growth, compared with an expansion of 2% for Ukraine. That’s because Ukraine has managed to keep its infrastructure running despite the fighting. And if it wins back some agricultural land and natural resources, it can increase exports, which for now have stabilized at about half their prewar level. Russia’s prospects for economic improvement depend on the success of its efforts to replace imports with local products. Any such substitution is bound to happen slowly given Russia’s extensive prewar dependence on foreign goods

Ukraine’s economic decline has been driven by horrendous physical destruction, which won’t be repaired for years even if the entire Western world chips in and Russia is forced to pay reparations. Russia has suffered little physical damage, with any economic toll coming mostly from sanctions. Those could be lifted following some kind of peace agreement—in theory making it easier for Russia to recover.

But any deal easing sanctions will likely require hefty reparations. If Russia manages a decisive battlefield victory and imposes its own peace terms, Western economic restrictions are almost certain to stay in place, while the Kremlin will be saddled with a multibillion-dollar check for rebuilding occupied areas brimming with hostile residents.

Add it all up, and it’s increasingly evident that neither side can emerge an economic winner—no matter what happens on the battlefield. Both will suffer crippling consequences long after the last shells fly.

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