To Really Hurt Russia’s Economy, Target Investment and Human Capital, Not Gas


In early 2015, I found myself presenting economic projections, via simultaneous translation, to an audience of po-faced Russian economists gathered in Moscow. We had gathered there at the Russian Presidential Academy of National Economy and Public Administration for an annual event where the government sets its economic agenda. But the audience wasn’t interested in our projections, which had been made just before the 2014 invasion of Crimea and the Western sanctions that followed. Instead, they wanted to know how much these sanctions would cost Russia, and just how vulnerable Russia was to even stronger Western sanctions. And so, in the months and years that followed, I performed research in this area with a team of Russian economists at the Gaidar Institute. This is an economic think tank in Russia with a unique connection to Russian leadership, and my time working with its staff gave me unique insight into how Russian technocrats think about sanctions. It might even have helped to influence these views.

At the start of the 2022 invasion of Ukraine, Western countries imposed severe sanctions on Russia, restricting Russians’ access to key dual-use products and technologies and pushing many Russian banks out of the global financial system. Two months later, the war is still raging. The Russian economy has taken a blow, but is far from collapse. One Russian analysis predicted a 9.2 percent contraction in GDP for 2022, roughly in line with Western predictions of -10 to -15 percent. While some sanctions, such as those on key technological inputs, will only bite in the long run, Russia has experienced other GDP declines of comparable amounts over the last 30 years, and there is reason to believe that the generational distribution of pain from sanctions will make this shock at least temporarily sustainable for President Vladimir Putin.



In this context, the West has debated how to further punish Russia economically. Two ideas in vogue are halting European purchases of Russian natural gas and seizing the assets of wealthy Russians held abroad. Contrary to the conventional wisdom, however, these actions would produce relatively little damage to Russia’s warfighting capacity or economy and may even prove to be counterproductive. The real key to damaging the Russian economy in the long run is to target investment and human capital. It is foreign companies and investment that drive Russian GDP and jobs, and talented young Russians who are the country’s hope for the future.

I came to these conclusions while researching the effect of sanctions on Russia in 2015, while I was a Ph.D. candidate collaborating with economists at the Gaidar Institute. Working at that think tank, blocks from the Kremlin, I learned about the tremendous importance of foreign investment to Russia. From 1992 through 2020, Russia experienced net inflows of foreign direct investment of over $715 billion (in 2022 U.S. dollars), or about 42 percent of Russia’s 2020 GDP. This represents a large stock of accumulated capital — literally machines, inventories, facilities, etc. — that creates jobs and output. If these assets are destroyed, repatriated, or otherwise permanently denied to the Russian economy, it will take a large share of Russia’s most technologically advanced and productive capital out of play. Some of this has occurred — Ikea, for example, has suspended operations, and 318 companies from Yale University’s tracker of over 1200 foreign businesses are completely exiting Russia. Unfortunately, however, that 318 figure also includes firms that are divesting themselves of Russian assets, often at fire-sale prices, meaning that many of their resources will still be available to the Russian economy. In addition, Russia has noted this danger and is taking steps to prevent it from effecting more industries. The government has implemented strict capital controls and threatened to nationalize businesses. Russia’s goal is to give foreign businesses two choices: unload their assets at fire-sale prices or continue operating as normal. Furthermore, the West has strengthened Russia’s ability to retain and even repatriate assets through its heavy-handed counter-seizures of wealthy Russians’ assets. Putin himself has pounced on these events, arguing in favor of repatriation by saying that “seizure of foreign assets and accounts of Russian companies and individuals is also a lesson for domestic businesses that there is nothing as reliable as investing in one’s own country.”

On the other hand, energy sales to the West (especially of natural gas) are, in aggregate terms, less important to the Russian economy. In the most recent data available (2020), rents from oil sales contributed 6 percent of Russian GDP, and rents from natural gas only 2.3 percent. In 2021, these values were likely higher due to high energy prices, but, still, energy as a share of Russian GDP has slowly been declining over time. In the medium term, sales (especially of oil) can be redirected to allies and the global south, albeit somewhat less profitably. China and India may be able to absorb much of Russia’s excess oil capacity in the relatively short term; oil also has a large and well established grey market. Finding new outlets for natural gas means building new pipelines or liquefied natural gas terminals, and therefore a shutdown would hurt Russia for longer, but new estimates strongly suggest that Europe would suffer more from a gas shutdown than Russia would. Germany alone, with an economy 2.5 times the size of Russia, is predicted to lose 0.5 to 3 percent of its GDP in the short run from ending Russian gas purchases. Even at the lower end of that range, it is clear that Western Europe as a whole has more to lose. With the clear upper hand here, Russia has been bargaining hard, and has even acted on its threats to shut off gas to Poland and Bulgaria.

These qualitative arguments are backed up by the simulations that I conducted with colleagues at the Gaidar Institute. The approach that we used to model the impact of sanctions is the “overlapping generations computable general equilibrium” framework. This type of analysis goes beyond simple “oil share of GDP” to think about knock-on effects (that’s the “general equilibrium” part of the title). This type of modeling is well-suited to understanding the medium- and long-term distributional and generational impact of a country being cut off from international trade. That said, these models are less good at predicting short-term consequences — say over a period of one to two years — or effects on a particular sector such as the defense industry, which has been an explicit target of Western sanctions. Our research, published in 2017, considered the impact of extremely strong and long-lasting sanctions under several scenarios, and likely informed Russian decision-making.

The most severe scenario that we simulated entailed Russia not being able to export its oil and gas while foreign capital completely exited the country (or was destroyed). This was projected to lead to a 43 percent decline in Russian GDP (versus baseline projections) after a year of sanctions, with the damage being very slowly repaired over time. GDP was projected to return to 81 percent of its no-sanction baseline projection after 25 years. This slow repair of the damage from sanctions is something that we saw in all of our scenarios. It would occur, in large part, due to the re-accumulation of capital over time from domestic Russian savings. An important silver lining of sanctions for Putin is that they force Russian oligarchs, who had previously reinvested their profits abroad or hid them in safe havens, to reinvest domestically ­— something that seems to be happening already. This has been a long-running goal for Putin. In fact, it might be exactly what he had in mind when he suggested that Russia might emerge stronger from sanctions.

The other scenario variations that we simulated help to isolate the impact of various factors. If the government were to seize all foreign-owned capital, we predicted that this would reduce the short-term impact of sanctions on GDP by 33 percentage points, and reduce the time until Russia catches up with baseline GDP projections by over 30 years. Being able to continue exporting oil and natural gas to the West were also seen to be important, but less so: versus our most severe scenario, being able to continue exports limited the impact of sanctions on GDP by only 3 to 7 percentage points, depending on the year. In other words, we estimated that the impact of eliminating foreign investments in Russia was up to ten times more important than ending Western energy sales.

My time in Moscow also revealed some interesting political economy aspects of sanctions that might have important long-term effects through Russia’s human capital accumulation and productivity growth. The Russian Federation’s government under Putin has been described as being dominated by two sorts of bureaucrat: siloviki (“securocrats”) who see all government action through the lens of conflict with the West, and technocrats who wish to focus on Russia’s modernization and economic development. It is the technocrats who were responsible for Russia’s economic rise from 2000 through 2008, which put the country in position to be able to invade Ukraine. These highly educated policymakers are a manifestation of a concession made by Putin because of his economic ambitions: The autocrat would allow and even cultivate a cadre of intellectuals with cosmopolitan lifestyles and somewhat liberal beliefs to run the economy efficiently, so long as these individuals didn’t rock the political boat.

However, technocrats have been increasingly marginalized from power. My last trip to Moscow was in 2015, just after the seizure of Crimea. I was there to present our projections of Russian long-term economic development for the Gaidar Forum. The mood among my Gaidar Institute colleagues was glum. They regretted the invasion, which they pointed out made Russia poorer on average (Crimean GDP per capita was lower than Russia’s and money would have to be spent on a solution after Ukraine cut the water supply), though were resigned to it given its popularity. On a personal level they were frustrated by a lack of cheese (a shortage that took years to rectify) and what it foretold: a greater disconnection from the rest of the world. They felt increasingly alienated and disempowered by the country they were supposed to be leading into prosperity. Some contemplated emigrating.

Young, highly skilled Muscovites leaving the country is a very bad potential outcome for Russia. Many have already left since the start of the current invasion. While we did not consider an explicit “brain drain” scenario in our simulations, we did find that even a small slowdown in Russian productivity growth due to sanctions could have large negative consequences. That said, we did find some interesting intergenerational consequences of sanctions that might help to insulate the regime. Older generations tend to suffer more from sanctions than younger ones. This is in part because an isolated Russia will face inflation and lower rates of returns on equity, effects that are more pronounced for those who have already accumulated assets to be affected. In addition, we calculated that 62 percent of Russia’s tax revenue comes from consumption (e.g., sales) taxes. (This doesn’t count the 38 percent of general government revenues that come from fossil fuel industry rents.) If Russia were to proportionately finance any government revenue losses using the same ratio of consumption and income taxes, the costs would fall harder on older Russians with fixed incomes versus younger Russians who would suffer more from increased wage taxation. Older Russians are more likely to support Putin, meaning that he has political capital to spend with this economically less-important group. In fact, rather than lowering consumption taxes to help older citizens, Russia has doubled down on trying to insulate talented young people from sanctions, lowering taxes on and providing other benefits to some critical groups of mobile young people.

In the weeks since the invasion of Ukraine, I’ve been in touch with colleagues in Russia again. One former colleague reports using Global Vector Autoregressive models — a data-driven short- and medium-term forecasting approach — to project the economic damage from sanctions. As of a few weeks ago he anticipated a 7 percent downturn in GDP this year. More recently these estimates have been revised negatively to 9 percent in the medium scenario and 11 percent in the worst one.

Comparing what has occurred in reality to the models that we simulated in 2017, he thinks that foreign-capital seizure, combined with a long-term productivity growth slowdown, best captures what has manifested. He agrees that our calculation of a 16 percent decrease in lifetime welfare for high-skilled Russians born around 1980 seems correct if the sanctions continue for a long time (while acknowledging there are wide confidence intervals). He is personally upset about complicity in the war but sees no better way to help his country (as well as calm himself) than to continue in his work. Those who contemplate leaving are offended by Putin’s characterization of them as “national traitors … those who earn money here, with us, but live there. And ‘live’ not even in the geographical sense of the word, but in their thoughts, in their slave-like consciousness.” My former colleague doubts that educated young people who are on the fence will be significantly influenced by Putin’s income-tax tweaks.

Where does this leave us? First, so long as the West can’t physically evacuate the projects that it has built in Russia or otherwise render them unavailable, the Russian economy will continue to plug along, and sanctions can only do so much. While it might come as a blow to Western companies, the West should apply pressure on firms operating in Russia to evacuate or destroy their assets rather than allow them to be seized or sell them at fire-sale discounts.

Second, the longer the war goes on, the more the Russian government can react to and ameliorate the lack of foreign investment. One important mechanism for this might be oligarchs reshoring their wealth and investing it domestically. By going after wealthy Russians, the West may actually be accelerating this process, and thus undermining the goals of sanctions. The aim should be to weaken Russia’s capacity to wage war, not to impoverish oligarchs, and every penny that they repatriate runs counter to that goal. Rather than viewing Russians who want to move their money and lives abroad with suspicion (a policy that will inevitably place burdens on the innocent), the West should work to encourage this ongoing drain of Russian money and capital. While obviously any corruption should be investigated and reported, outright bans on Russian visas, such as that recently applied by the Netherlands, are completely counterproductive. The argument that placing pressure on oligarchs, who will then place pressure domestically, could help destabilize Putin’s regime is wishful thinking that ignores the fact that current oligarchs aren’t independent titans of industry but rather spineless survivors and lackeys. Instead, the West should be doing what it can to accelerate the emigration of Russia’s best and brightest. Things are bad for Russia’s economy now, but it would be in even worse shape without the disgruntled but technically sophisticated Muscovites who Putin despises.



Seth Gordon Benzell is an assistant professor of management science at Chapman University, Argyros School of Business and Economics. He is a fellow of the MIT Initiative on the Digital Economy, and the Stanford HAI Digital Economics Lab. His research has appeared in prestigious economics and general science outlets, including AEJ: Applied Economics, the National Tax Journal, and PNAS. He can be followed on Twitter at @SBenzell.

Image from Russian government news.