The big development in the Russia-Ukraine war is not the latest US aid package, or Ukraine’s audacious incursion into the Kursk region of Russia. The most consequential development is the huge increase in Russian defence spending for the next year. Vladimir Putin has turned Russia into a war economy.
Putin’s former economic adviser Andrei Illarionov predicted in an October 2022 interview with the German newspaper Die Welt that Putin would by now have run out of money: Russia’s foreign reserves would last only for one more year, and then there would be a currency crisis. Illarionov’s comments were a monumental misjudgement, of the sort that has become typical of Western commentary about Russia’s war. Since then, the exact opposite has happened. Russia’s economy is roaring. The International Monetary Fund has said it will grow faster than those of all the big G7 countries this year – thanks to the war economy effect.
When you listen to the debate in Germany or the US about support for Ukraine, you might get the impression that it is the West that is running out of money. This is not true either. But we are running out of a willingness to spend it.
Since the start of the Russia-Ukraine war, Europe has been teetering on the brink of recession. Europe was dependent on Russian gas and on industrial supply routes that cut through the country. If the West was really serious about helping Ukraine defeat Russia, it would have to follow Putin’s lead and switch to a war economy: shift money from other parts of its budgets towards higher defence spending, and specifically for weapons for Ukraine. None of the large Western countries are ready to do this. Germany is fast moving in the opposite direction, cutting all of the aid budget it has not yet allocated to Ukraine.
Last year, Russia spent Rbs6.5trn on defence, a little more than £50bn at today’s exchange rate. This year, this has risen to Rbs10.8 trn roubles, and next year it is foreseen to reach Rbs13.2trn. This is more than 6 per cent of the economy’s output. Many Western countries are struggling to reach 2 per cent.
There is a lot of muddled thinking about what happens to economies during a war. Economies do not run out of money – unless they use another country’s currency, such as the US dollar. A war economy is the biggest imaginable Keynesian-style fiscal boost.
The Russian war economy is running on steroids and generates huge revenues for the state. Non-oil and gas revenues are projected to rise by 73 per cent next year. Russia is not funding its increased defence through debt, but through a booming economy.
To insist that the West needs to defeat Putin is cheap talk. I read it again from Norbert Röttgen, the foreign affairs spokesman of Germany’s Christian Democrats (CDU). He said “diplomacy has a chance only once Putin recognises that he cannot achieve anything through war”. Röttgen’s CDU is opposed to a change to Germany’s tough fiscal rules to allow an increase in military spending. If the West was serious about defeating Putin, we too would double our defence spending, as Russia has done. We would first need to agree how this would be financed: higher taxes, or cuts in pensions and welfare payments? Even less investment in our crumbling public infrastructure? Maybe more debt? Germany, not Russia, is struggling with its defence budgets. And if anyone will come to recognise that continued war is futile, it is less likely to be Putin than Ukraine’s tired Western supporters.
The West’s Ukraine war narratives are mainly informed by wishful thinking – about Russia running out of money, about the impact of sanctions on the Russian economy, about our own political appetite to support Ukraine after the initial period of pro-Ukraine euphoria ended. The Western alliance is clear only about its red line – that it does not want to engage in a war with Russia directly. I agree with that position. But it does not constitute a strategy. Given this red line, there is no scenario in which Ukraine could liberate the territories occupied since February 2022. I do, however, see a scenario in which Putin could achieve his main war goal, the annexation of four Ukrainian oblasts: Donetsk, Luhansk, Zaporizhzhia and Kherson.
This is not a prediction, but a warning that the West urgently needs to adopt a more realistic war strategy, rather than funding an open-ended conflict that Ukraine has no chance of winning. US support for Ukraine is still holding up, but at a lower level. The foreign policy priority for the US right now is the Middle East. If Donald Trump wins the presidential election next month, the West’s entire Ukraine policy will be upended.
Whatever happens, the Europeans are not going to fill any gaps left by the US. Michel Barnier, the new French prime minister, has just announced a €40bn austerity budget for next year. Austerity has also returned to Italy. But it is Germany where I see the support for Ukraine dwindling the most.
Dietmar Woidke and Michael Kretschmer, the state premiers from Brandenburg and Saxony, respectively, together with Mario Voigt, the CDU leader of Thuringia, published an article on 3 October in Frankfurter Allgemeine to press the case for a peace conference. The political establishment in Berlin rightly interpreted this as an attack on the government’s sending weapons to Ukraine. The trio is at the heart of the centrist policy establishment. They all depend on the support of Sahra Wagenknecht, who emerged as a power-broker in east German politics after the recent state elections. She has become the most outspoken opponent to Germany’s support for Ukraine, a position shared by the left of Chancellor Olaf Scholz’s Social Democratic Party (SPD). Wagenknecht is pushing the SPD in a direction that many of its members want it to be pushed.
Scholz now says he wants to resume a dialogue with Putin, after two years of not speaking to him. The German chancellor desperately needs this war to end before next year’s federal elections. He does not want to put himself in a position where he, too, relies on Wagenknecht for support.
Scholz believed at one point that a war of attrition would favour Ukraine. It was a consensus view in the West that they would win a staring contest with Putin. Now Russia has transitioned to a war economy, the balance of power has shifted in its favour. Germany will have to find some €30bn (£25bn) a year just to meet the Nato defence spending target of 2 per cent of GDP. It would need to spend a lot more to provide Ukraine with its share of the funds needed to defeat Russia. Germany is already one of the world’s highest taxed countries. There are no political majorities for raising them. Nor for spending cuts or higher debt. Its coalition is not ready to do whatever it takes to support Ukraine.
Scholz is now talking about diplomatic solutions to end the war. His diplomacy falls into the hopeless category: peace talk is cheap. Scholz called for Russia to participate in what was hailed as a peace conference in Switzerland in June, but Russia has already said it is not interested in a meeting heavily biased towards Ukraine’s supporters.
Scholz’s futile diplomacy is a reminder that the West has reached a dead end in its Ukraine strategy. The original idea was to isolate Russia, which led to it deepening its alliances with China, Iran and North Korea. Russia and China, for example, are strengthening their commercial and military ties. A notable area for bilateral Russian-Chinese cooperation is the Arctic, a weak spot of Western security. Russia has built up its military capacities in the Kola Peninsula, its border region with northern Finland. Russia’s state-owned nuclear energy firm Rosatom and China’s Hainan Yangpu NewNew Shipping company have created a joint venture to build infrastructure and ice-class container vessels to operate a year-round Arctic route.
The West underestimated China and Russia at every turn, and overestimated its ability to draw other countries into the Western alliance. India, Brazil and South Africa all said no. Europe, meanwhile, is hopelessly divided.
Austria still gets most of its gas from Russia – accounting for 83 per cent of Austrian gas imports. That gas travels through Ukrainian pipelines, one of the few Russian supply routes to Europe still running. But the transit contract between Ukraine and Russia is due to expire at the end of the year, and Ukraine has said it does not wish to renew.
To say that this will upset the Austrian economy would be an understatement. When Germany found itself in a similar situation two years ago, when Russian gas pipelines were blown up in the Baltic Sea, it took a big effort to redirect gas supplies. Austria is in a weaker position because it has no direct access to the sea and cannot build port terminals for liquid natural gas as Germany did. It would have to procure its gas on global markets through third parties, at a higher cost.
This issue could easily get tangled with the formation of Austria’s new government after the victory of the hard-right Freedom Party of Austria (FPÖ) in the recent election. The FPÖ, too, wants to stop weapons deliveries to Ukraine. Slovakia and Hungary, Austria’s neighbours to the east, are run by politicians friendly towards Putin. And I note a change in tone from the Polish government: its willingness to supply Ukraine with weapons has reached a ceiling.
We should start thinking about endgames, not restating mantras and maximalist positions. If you frame the war in terms of victory and defeat, you are more likely to end with defeat than if you adopted a more nuanced and flexible strategy. The best way forward would be to switch to a defensive war: to stop Russia’s advances, but not to push back, and to step up Western military aid in support of this restated war goal. It takes fewer troops to defend territory than to occupy it. It is also easier to organise political majorities behind a strategy that stands a chance of succeeding. Even this more modest goal would require an increase in defence spending; it would not be a cheap option, nor would it be a surrender.
If we continue on the current path, there is a serious possibility that the West will lose the staring contest.
