[War & Business] The Other Side of the 'Potemkin Economy'

Portraits of Grigory Potemkin, Prince of Russia who succeeded in occupying the Crimean Peninsula in 1787 (left), and Empress Catherine II, the emperor at the time (second from the left). [Image source=National Museum in Warsaw, Poland website]

[Asia Economy Reporter Hyunwoo Lee] There is a term called ‘Potemkin Economy’ used to describe the Russian economy before and after Russia's invasion of Ukraine. This term, meaning something that looks flashy on the outside but is hollow inside, is often used sarcastically to describe the Russian economy, whose ruble value has been soaring daily despite sanctions against Russia.

Originally, this term came about in 1787 when Russia first occupied the Crimean Peninsula. At that time, Catherine the Great, the Russian Empress, went on an inspection tour of the newly occupied Crimea and toured the surrounding area by pleasure boat. To deceive the Empress, Grigory Potemkin, the commander who occupied Crimea, created fake beautiful ghost villages, which later came to be called ‘Potemkin Villages’?fake villages built for show.

Later, around the collapse of the Soviet Union, American economist Paul Krugman likened the Soviet economy to these Potemkin Villages and coined the term Potemkin Economy. After the invasion of Ukraine, Western media also flooded with articles claiming that the Russian economy was in a Potemkin Economy state and would soon completely collapse.

However, the so-called fragile Potemkin Economy of Russia has shown no signs of collapse even after four months of war. As of May, Russia’s current account surplus increased 3.5 times compared to the same period last year, exceeding $110 billion (about 143 trillion won), and Russia’s default (debt default) after 104 years is at a very minimal level of about $100 million. Even when combining all of Russia’s external debt, it amounts to about $40 billion, which is only about one-sixteenth of the estimated $640 billion in foreign exchange reserves.

Experts agree that the reason for the significant difference between the Soviet Potemkin Economy and Putin’s Potemkin Economy lies in international oil prices. The collapse of the Soviet Union was largely due to the impact of low oil prices rather than planned economy issues. In November 1985, international oil prices maintained an average of around $30, but by July 1986, they plummeted to the $10 range. During Korea’s high-growth period known as the ‘3 lows boom,’ the Soviet Union’s finances completely collapsed, leading to state failure.

However, the current international environment for Russia is one of historically high oil prices. Despite fluctuations, international oil prices rarely fall below $100. Even though Russian oil is being sold to China, India, and others at prices more than 30% cheaper than the international oil price due to sanctions, Russia is still posting record-high surpluses, which explains this situation.

Voices of reflection are emerging in the U.S. and the West, admitting that they underestimated Russia’s economic strategy by dismissing it as a Potemkin Economy. They acknowledge that Russia’s ‘economic fortress’ policy, prepared through over 11,000 sanctions since the 2014 Crimea invasion by the European Union (EU) and other sanctions, was taken too lightly. Over the past eight years, Russia has drastically reduced its external debt, built up foreign exchange reserves, and established substantial self-sufficiency measures for food and key resources.

As it becomes clear that the Potemkin Economy was not entirely unprepared, concerns about the prolonged war are increasing. The worst-case scenario, where the supply chain crisis may not end quickly, should always be assumed, and our government must prepare accordingly.