Russia’s Defense Industry and Its Influence on Policy: Stuck in a Redistributive Feedback Loop

Russia’s Defense Industry and Its Influence on Policy: Stuck in a Redistributive Feedback Loop

Pavel Luzin

Russia’s defense sector, like its U.S. counterpart, forms a key aspect of the country’s national power. Unlike American defense companies, however, the Russian defense industry largely belongs to the state, de facto if not always de jure. Accordingly, Russia’s large defense corporations and their subsidiaries compete not in a free market but within a so-called administrative market—an ongoing redistribution of government resources, mostly via Moscow, among players important to the political system and its sustainability. The industry bolsters Russia’s modern-day authoritarianism not only by projecting power but by providing a major part of the system’s social base—from the ordinary Russians who benefit via employment to the political elite involved in managing the industry or reliant on its contributions to local coffers. This gives the state too little freedom to reform a sector plagued by economic inefficiencies that create a drain on the budget, leading instead to the partial restoration of a command economy and raising the specter of economic overstretch.

When considering Moscow’s policies toward the United States and NATO, the Russian defense industry’s influence can only be understood in the context of this administrative-market-driven feedback loop: In its foreign policy, the Kremlin relies on asserting its military might and on continued legitimacy in the eyes of Russian citizens; consequently, it needs to keep the defense industry afloat, covering the constantly growing costs and sometimes making up work for enterprises that would be redundant in a true market—including the manufacture of weapons deemed threatening by Washington and Brussels. Thus, Russia’s defense corporations and the people affiliated with them become both beneficiaries and proponents of Moscow’s ongoing confrontation with the West.

Evolution of Russia’s Defense Industry Since the Cold War

The past 30 years have seen Russia’s defense industry go on two interconnected roller coaster rides—economic and organizational. The first involved plummeting government spending and failed efforts at conversion, followed by strong growth in spending since 1998. The second involved the collapse of Soviet-era chains of command, supplies and manufacturing, followed by ersatz privatization that benefitted new elites and ultimately a reconsolidation of the industry under official state ownership. Today, these processes have culminated in the state’s domination of this strategic industry, with the private sector represented only nominally.

The economic decline of Russia’s defense industry came on the heels of the Soviet collapse, when arms procurement and R&D programs shriveled. Military expenditure fell from a yearly average of just over $254 billion in 1988-1990 to just $15.7 billion in 1998, according to estimates by the Stockholm International Peace Research Institute (figures in constant 2019 dollars1). Attempts at conversion to non-military production—begun in the late 1980s—had failed completely by 1993. Russia’s defense industry managed to survive the crisis years through its continued ability to produce and service weapons, drawing on Soviet-era inventory and foreign demand for conventional arms and technologies, mostly from China, India and other developing countries.

Throughout the 1990s, Russia’s approach toward the defense industry involved a balancing act of finding new partners and decoupling from old ones—mainly to improve domestic manufacturing of advanced civilian goods like aircraft engines. On one hand, Russia relied on cooperation with Western businesses, allowing them to partner with and/or buy stakes in Russian defense companies. Western governments, meanwhile, worked with Russia on space programs and bankrolled disarmament programs. (This sometimes led to paradoxical situations: For instance, Russia dismantled dozens of Soviet-era nuclear submarines with Western financial assistance while independently building 16 new ones.) At the same time, Russia tried to reduce its dependence on other ex-Soviet republics for defense manufacturing—fully localizing, for example, the production of various types of missiles formerly made in Ukraine.

As the Kremlin tried to maintain control of the defense industry amid the chaotic competition for resources during post-Soviet privatization, power in the industry was redistributed. The big loser turned out to be the Defense Ministry, previously engaged in managing plants and shaping industrial policy. Instead, defense companies came under the control either of formally private entities affiliated with the new Russian authorities (e.g., KASKOL group) and with the Federal Security Service, a.k.a. the FSB (e.g., FondServisBank), or of individual FSB officers. The Kremlin wanted, of course, to maintain Russia’s status in global affairs and to avoid discontent among millions of employees, but it also had goals specific to the tumultuous 1990s: getting top managers on the side of the new Russian political elite; preventing the industry’s criminalization; and restoring defense manufacturing capabilities after the defeat in Chechnya.

Under President Vladimir Putin, the defense industry turned to consolidation and restoration of formal state ownership amid a larger consolidation of Russia’s authoritarian governance. The state’s monopoly on arms export was restored in 2000-2007 in the hands of Rosoboronexport, which eventually became a subsidiary of Rostec—one of about half a dozen specialized state-owned defense holdings created in 2002-2015. Each of these holdings, or corporations, has a complex tangle of administrative and economic interests:

The boards of directors are full of officials from the government and presidential administration;

Top managers hail from either the defense industry or the security services and intelligence;

Having defense factories in different regions gives governors a vested interest in supporting the industry; and

CEOs principally oversee financial flows and balance interests/mitigate conflicts within the holdings.

Also under Putin, Russia has restored a de facto command economy within the defense industry, which does not help the sector overcome its challenges. One set of government measures involves rebooting the conversion program—Russian defense enterprises are to increase their share of revenue from civilian products to 50% by 20302—and obligating government entities and state-owned companies in other sectors to buy the resulting civilian goods. In part, this approach arose as Moscow tried to find alternatives to Western components and contain costs: Russian cooperation with Western defense companies, declining since the 2000s, has all but ended due to post-Crimea sanctions, leading in turn to exorbitant procurement costs for the defense industry, which still depends on imported electronics, especially in the space sector, and some other imports. Predictably, the industry still suffers from economic inefficiency, a lack of technologies and, consequently, a lack of human capital.

Whether through top-down purchasing directives or state officials in key management posts, Russia’s government remains deeply involved in the country’s defense industry. One example of the state’s heavy hand is the above-mentioned obligatory purchases of civilian goods. Another is the intermingling of state-owned defense corporations with private businesses linked to senior Russian officials. Just one example: In 2014-2018 Rostec sold a 75% stake of Kalashnikov Group to a company controlled by Alexei Krivoruchko, who became a deputy defense minister in June 2018 and sold his stake to former Deputy Transport Minister Alan Lushnikov; Lushnikov, meanwhile, is a business partner of retired Maj. Gen. Timur Gareyev, who sits on the board at Tactical Missiles Corporation, one of the state-owned defense holdings.

Today, Russia’s defense sector is an integral part of the country’s political system, where the distribution of state resources depends on continuous bargaining among various stakeholders, and thus differs from its U.S. and Chinese counterparts. The U.S. defense industry, for instance, is not state-controlled; despite a strong reliance on government contracts and the “revolving door” among defense executives, lobbyists and government officials (not to mention contributions to political campaigns), the sector is separate from the U.S. political system and operates in the context of commercial markets and competitive politics subject to democratic checks and balances, including a powerful legislature and courts. China’s defense industry, like Russia’s, is state-controlled, but the Communist Party has retained its central role as mediator of competing political, bureaucratic and economic interests. Russia’s sector, meanwhile, involves a more complex balance of group and personal interests, networks and patron-client relationships.

Influence of Defense Industry on Government Policy

Within Russia’s current model of governance, the defense industry’s influence flows from the priorities on which Russia’s authorities have based their legitimacy: catch-up modernization and restoring Russia’s military power and greatness. As long as the industry contributes to these goals it remains crucial to the system. At the level of big-picture foreign policy then, Russia’s defense sector does not so much influence the Kremlin’s position as perpetuates it; at the same time, the needs of the industry sometimes dictate government decisions to produce particular weapons or equipment, whether they are genuinely needed or not, and some of these can in turn seem threatening to adversaries like the U.S. and NATO.

Russian defense companies do not need to spend money on lobbyists (as their U.S. counterparts do) because key individuals working for them simultaneously hold senior political posts and already take part in high-level decision-making. Thus, Russia’s defense-industry lobbying, such as it is, focuses on access to the federal budget—funds distributed by the government with the active participation of the presidential administration and Putin himself for arms procurement, R&D and industrial modernization programs. Russia’s leadership, in turn, tries to maintain control over the industry—which it considers to be a driver of progress in high technologies and in Russia’s state-led economic modernization overall—and to maintain balance among the sector’s interest groups by redistributing the state’s limited resources in order to achieve political and economic goals while retaining the loyalty of the system’s beneficiaries and making sure that none is left out in the cold.

This bargaining for resources—largely to determine which defense enterprises get to fulfill which state orders—involve multiple layers of interest groups, including companies’ workers, managers and executives, as well as federal and regional government officials, operating through formal and informal channels, both publicly and behind the scenes. The industry includes about 1,300 entities, most of which fall under the aegis of the state-owned corporations Rostec, Almaz–Antey, Roscosmos, Tactical Missiles Corporation, United Shipbuilding Corporation and the nuclear weapons division of Rosatom. The sector’s roughly 2 million employees amount to about 2.7% of Russia’s labor force.3 Russian ministers, deputy ministers and presidential administration officials sit on the corporations’ boards of directors, while FSB officers work in management. Moreover, there is competition within each corporation: Different divisions, subsidiary companies and individual plants compete for their share in manufacturing and R&D programs. Regional officials play a comparatively minor role here, but they want defense manufacturing in their regions for reasons not unlike those in the U.S.: It means more jobs, additional investment into infrastructure and a plumped-up tax base. These boons, in turn, improve such officials’ standing within the Russian political hierarchy. Sometimes, the bargaining for resources takes place in the press, with the heads of Russia’s defense corporations commenting on issues far beyond their official remit.4 Moreover, each defense corporation tries to tout its successes in advancing the modernization agenda, participates in patriotic education programs and conducts other activities in support of state priorities.

In some instances, the Russian leadership adapts its defense policies to prop up parts of the industry in ways that could have a direct bearing on U.S. and NATO military planning. A case in point is the Sarmat ICBM now under development. One U.S. publication has called this heavy, liquid-fuel missile “Russia’s doomsday weapon,” adding that it “makes America’s 39-ton Minuteman ICBM look like a rocket-propelled toothpick.” The missile is a modification of the Soviet-era R-36M Voyevoda; initially, however, Russia’s long-term plans had been to replace all its Soviet-era liquid-fuel ICBMs and SLBMs with new, solid-fuel missiles. But such a policy would effectively require the shuttering of a Roscosmos subsidiary, the Makeyev State Rocket Center, whose primary activity for several decades had been the manufacture and modernization of R-29RMU2 liquid-fuel SLBMs.5 In short, Russia launched the Sarmat program in order to provide the Makeyev Center with a long-term work load, despite the original decision to do away with liquid-fuel missiles.

The Sarmat case offers a good illustration of how the “administrative market” works, pursuing a politically acceptable balance of interests among different groups and individuals: Roscosmos retains industrial assets in the Chelyabinsk and Krasnoyarsk regions; regional (and federal) authorities avoid social upheaval due to large-scale lay-offs; the Ministry of Industry and Trade avoids trouble with supply chains connected to Makeyev’s handful of military and civilian products unrelated to R-29RMU2s; the armed forces can slowdown their reduction of strategic forces amid the ongoing dismantling of old ICBMs and SLBMs; and the Kremlin gets another strong card for bargaining with the United States and the West writ large. Meanwhile, the entire system of Russian leadership maintains its reputation in the eyes of its citizens by showing it can solve problems and strengthen Russia’s military capabilities.

Defense Industry Interests vs State’s and Public Interests

In developing policy toward the defense industry Moscow faces an inherent contradiction: On one hand, Russia’s leadership needs on efficient defense sector that acts as a source of the country’s power and legitimacy, producing arms for export and advanced high-technology civilian goods; on the other, the domestic political and economic order—with its bureaucratic over-regulation and the absence of private initiative in defense manufacturing—contributes to an inflation of costs and general economic inefficiency in Russia’s defense industry. Thus, the Russian leadership is forced to maintain a money-guzzling sector despite limited resources and sometimes contrary to its own strategic goals. This, obviously, leaves less money for other types of public spending and hinders economic modernization overall.

Moreover, the complex balancing acts within Russia’s administrative market mean that the authorities do not have enough freedom of action in dealing with the defense industry. Due to the sector’s organizational entanglement with institutions of power, and consequently the political weight of the vested interests involved, any efforts to downsize the sector risk causing major political upheaval. Even within each defense corporation, competition among its subsidiaries means that key players resist optimization and reorganization efforts that could undermine their interests but support those likely to bolster them.

Another specific example similar to the Sarmat program concerns combat aircraft manufacturing. In 2008-2020 the Novosibirsk Aircraft Plant made 124 Su-34 fighter bombers for the Russian military. In the following decade the military planned to commission no more than 48 additional Su-34s and there were reportedly plans to transfer production to a different plant, in Komsomolsk-on-Amur, in an effort at streamlining. By 2018-2019, the Novosibirsk plant had started significant staffing cuts. But growing backlash from the public and the regional authorities resulted in a reversal and the Defense Ministry was forced to contract the production of 76 more Su-34sto be delivered by the plant by 2027.

The attempts at conversion also cost the government money. While it is hard to estimate total investment, some numbers suggest that the defense industry gets hundreds of billions of rubles annually—in state-backed civilian procurements, government investment and projects aimed at modernizing and diversifying the defense sector. Civilian procurements under the government’s ambitious “national projects,” for example, are planned at 6.2 trillion rubles by 2030 and, according to Russia’s Ministry of Industry and Trade, the defense industry could potentially provide half of the goods in question.6 The price tag of the state-sponsored MC-21 commercial aircraft is reportedly set to surpass 437 billion rubles ($7 billion) by 2025, with the cost of developing the engine alone exceeding 70 billion rubles (more than $1 billion).

The government does try to decrease the number of companies that are chronically money-losing, so too many unsolved economic problems can lead to defeat in the administrative market: For instance, debt burdens at two leading state-owned defense corporations, Uralvagonzavod and the United Aircraft Corporation, led to their absorption by Rostec in 2016 and 2019-2020, respectively.

Permanently Growing Costs of Russia’s Defense Industry

The most significant evidence of the Russian defense industry’s economic inefficiency is the sector’s growing debt burden, which highlights rising costs but also foreshadows continued increases in military spending. Between 2019 and 2020 the defense industry’s total debt burden increased from 2 trillion to 3 trillion rubles—or nearly $31 billion to $41.6 billion—up from 1.2 trillion rubles ($19 billion) in 2016.7 Moreover, the defense sector has been incapable of paying off these loans: In 2019 the deputy prime minister overseeing the sector recommended writing off up to700 billion rubles of debt; the following year, 350 billion rubles were completely written off and 260 billion more were restructured; in 2016, the government paid off 800 billion rubles ahead of schedule to free itself of mounting interest payments. Thus, the Russian leadership will be forced to increase its defense budget in the coming years, regardless of current financial planning. Dollar and ruble figures in Tables 1 and 2 below are in current prices for each respective year.8

Comparing military spending as a share of the federal budget in Soviet times with that in today’s Russia is difficult, due to both the secrecy and the accounting practices associated with that spending. However, if we try to calculate the change by taking SIPRI’s estimates of total military expenditure in rubles and comparing them with Soviet/Russian Finance Ministry data on budget expenditure for 1988 and 2020 (also in rubles), the drop in military spending as a share of the budget in those years would be from 30.1% to 10.5%. That said, Russia today is far lower on economic, technological and human resources than the Soviet Union was, while the costs of defense manufacturing have become much higher. Consequently, the Russian defense industry’s economic problems have become harder to manage.

How to Lessen the Defense Industry’s Deleterious Effects

Russia’s defense industry creates significant imbalances within the country’s defense policy and economy, hindering optimization efforts and forcing Moscow to spend more and more on defense at the expense of other priorities. Major improvements are impossible without deep institutional reforms, as well as some measure of reconciliation with the West and significant steps toward economic liberalization in all sectors of Russia’s economy. Nevertheless, some minor improvements are possible without that:

The defense industry needs more organizational and decision-making flexibility: Over-regulation must be decreased and the current spy hysteria—when engineers and researchers regularly face spurious charges of espionage and treason—must be completely stopped. Responsibility for economic efficiency (including workforce productivity) should be partly delegated to management.

Conversion and diversification efforts in the industry should continue but should be incentivized by lower taxes and fewer regulations instead of protectionism (e.g., closing off Russia’s domestic market to foreign suppliers), bureaucratic enforcement and direct financial assistance.

The defense industry should take every opportunity to cooperate with universities, the civilian machine-building industry and small business. The Defense Ministry should also increase the share of private-sector and university research teams in defense R&D and procurements.

Arms export should be demonopolized to create incentives for defense companies to supply their products directly to foreign customers instead of sharing profits with Rosoboronexport.

All arms procurements must be carried out by a civilian government acquisition service.

Civilian and military officials must be excluded from the defense corporations’ supervisory boards in order to eliminate conflicts of interests.

Ultimately, the Russian defense industry’s influence on the government derives from the nature of the country’s political and economic system. The interests of state-owned defense corporations and their subsidiaries are too deeply intertwined with the interests of ministries and federal agencies, the Kremlin and the entire political elite, not to mention the personal interests of Putin’s inner circle and other high-ranking officials. This administrative-market system does not accommodate proper oversight and decisions concerning the defense industry are determined primarily by political rationale.

Despite the fact that Russia’s political elite tries not to repeat the mistakes that led to the Soviet collapse, the risk of economic overstretch is growing. The defense industry’s rising debt burden and the government’s intense spending on the sector—on procuring arms and civilian goods, investments into defense manufacturing itself and diversification of the defense corporations—suggest that balancing between market and command-administrative sectors within the Russian economy will become increasingly challenging. This in turn raises the question of the economy’s overall sustainability and, consequently, the question of the long-term sustainability of Russia’s political system.

Footnotes

Although these figures are adjusted for inflation, which is normally considered the more reliable way to reflect price changes over time, calculating Russia’s defense spending in dollars is problematic since most military equipment is paid for in rubles; thus, dollar figures reflect changes in the ruble-dollar exchange rate at least as much as changes in actual spending. (See Table 1 and footnote 9 for examples.)

For comparison, in 2020 the share of civilian products in Rostec’s revenue of nearly 1.9 trillion rubles ($26 billion) was 33.9%; the United Shipbuilding Corporation’s was 20.4% of its 338.5 billion rubles ($4.7 billion) in revenue.

In the late Soviet period, according to data cited by Tufts professor Chris Miller, Moscow’s defense-industrial complex employed about 10% of the workforce, or some 15 million people.

Examples include: Sergei Chemezov of Rostec, Dmitry Rogozin of Roscosmos and Alexei Likhachev of Rosatom.

The production of new ICBMs and SLBMs, the Yars and Bulava, respectively, is concentrated at another Roscosmos subsidiary, the MIT Corporation.

In 2020, nearly 1.8 trillion rubles ($24.5 billion) in subsidized loans went toward stimulating industrial export, though the defense industry’s share remains unclear.

Dollar figures based on average exchange rates for the respective year.

While changes in earnings and expenditure over time are often more accurately reflected with calculations adjusted for inflation (e.g., using constant-price data) and purchasing power parities, these approaches must be used with caution in the case of Russian defense spending as they can distort the picture rather than illuminate. Using constant rubles, for instance, can yield inaccuracies because the producer price indexes in industries related to defense manufacturing differ significantly from the basic GDP deflator year by year. For research using PPP adjustments to calculate defense spending see, for example: Richard Connolly at CNA, 2019, and Vasily Zatsepin at Gaidar Institute for Economic Policy, 2018. We have included inflation- and PPP-adjusted calculations of Russia’s defense spending in the Appendix at the end of this article.

Note that while spending in rubles rose by 28.3% from 2014 to 2015, spending in dollars in the same period fell by 19.4%. For an explanation of this seeming contradiction and the ostensible drop in spending from 2016 to 2017, see Kofman, Michael, “The Collapsing Russian Defense Budget and Other Fairy Tales,” Russia Matters, May 22, 2018.

All military spending formally comes from the federal budget; the consolidated budget includes the federal, regional and local budgets.

Courtesy: (Russiamatters)

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