Russia’s current economic situation poses complex problems for the Kremlin, but it might hypothetically lead to a more competitive and diversified market economy based around technology, innovation and valued-added manufacturing.

A woman leaves an exchange office with a sign showing currency exchange rates in Moscow on Jan. 20. Photo: AP

Some members of the Russian public might be predisposed to think of the West’s sanctions and the current economic crisis as negative. That may be true for the short-term. But it is not ruled out that in the longer term, this situation might prove positive, outweighing the short-term discomfort. Crises such as today’s ruble crisis leave countries with no other option but to “bend the stick” – to see how far their economies can stretch without breaking.

Today’s economic turmoil is testing Russia’s flexibility and strength, allowing the nation to identify neglected areas of the economy and introduce reforms to increase efficiency and resistance to later shocks. And the more diversified and institutionally resilient Russia becomes today, the greater its future success. The past experience might be helpful to a certain extent. Russia is no stranger to grim economic predictions and crises. It endured economic “shock therapy” in the 1990s in its transition to capitalism. By 2001, only three years after the 1998 financial collapse, the economy was performing well enough for Goldman Sachs to include Russia among the emerging market BRIC nations. Russia also weathered one of the worst international financial crises in recent memory between 2007 and 2009.

These examples demonstrate the robustness of Russia’s economy in recent decades. That ability to bounce back provides appropriate context for discussing the current state of affairs. Today, against the backdrop of the Ukraine crisis and Western sanctions, Russia finds itself in a short-run economic contraction exacerbated by a drop in oil prices and the ruble.

With diversification and institutional reform, the economy can emerge stronger than ever, however. Making the right moves now could leave Russia better prepared for future cataclysms and better positioned to take its rightful role on the international stage.

In response to the sanctions and oil-price shock, the government stepped up diversification efforts and called for production of more value-added goods. Relying on raw materials served Russia well in the past, but the recent tectonic shifts in geopolitics means it’s time for change. The shift to a more diversified economy not only needs to include moving existing industries up the value chain but also developing entirely new industries.

The good news is that the change in thinking underlying such a shift has already begun. Since the sanctions were introduced, government officials have repeatedly called for developing non-petroleum sectors of the economy, ramping up innovation and high technology, and broadening the base of Russia’s international partnerships in the Asia-Pacific region. In addition, in recent months it’s revved up a program to export high-tech goods. It’s also broadened its partnership base by shifting its imports of agricultural goods from Europe to Central Asian and Latin American suppliers.

There are signs of the evolution in thinking at the Kirishi-2 Oil Refinery, Russia's first waste oil refinery, to launch in 2017. Since the fall of the Soviet Union, Russian oil companies have shipped millions of tons of “waste oil” overseas, for pennies per ton. Now it could be possible to convert waste oil into petroleum products. The government has always backed the project, but since the West imposed sanctions, it’s become even more supportive.

A major shift in the economy will generate long-term benefits but will inevitably require short-term sacrifice. A brief example will suffice: The government is reducing military-electronics imports to try to develop the domestic industry. The goal is to have 95 percent of military electronics made in Russia by 2020.  

Even though it will be challenging, import substitution could not only improve existing domestic industries but also spur the development of new ones. The bottom line is that Russia could hypothetically exit the crisis with a stronger production capability.

This kind of major economic shift cannot be accomplished in one or two years and could lead to higher domestic prices in the short run. The benefits of the shift should begin kicking in over the medium term and be fully realized over the long term.

To facilitate the shift to more innovation, more high tech and more valued-added products, the government and private sector need to come up with additional sources of funding for research and development (R&D). Much of the R&D could be done at Russian universities, long a world-renowned source of scientific achievement and innovation. Today, innovation and information technology play a key role in the world economy. Russia needs to make better use of its comparative advantage in brainpower to become a leader in this area.

Another move Russia needs to make to become stronger and more competitive over the long term is to continue developing the Eurasian Economic Union which is also challenging. The more economic integration its members achieve, the stronger their economies and their collective political clout. As the largest member of the bloc, this is particularly true for Russia. Russia needs to help smooth out snags in the integration process on the basis of member equality and sovereignty and the collective economic good. The goal must be for all member states to reap benefits from the union that bolster their economies and improve their people’s livelihoods – and that attract new members.

Although coping with sanctions, a drop in oil prices and a devalued ruble is challenging, it is paramount that Russian leaders spend time and energy to address the economy’s structural problems. That’s the only way to create an economy that is more robust, more efficient and more flexible in years to come.

The opinion of the author may not necessarily reflect the position of Russia Direct or its staff.