Russia’s Defense-Industrial Complex at a Crossroads: Aura Versus Reality (Part One)

On March 31, during a virtual meeting with the Kremlin, the president of the Federation of Independent Trade Unions of Russia (FNPR), Mikhail Shmakov, proposed that any companies operating within the domestic defense industry (DI) sector that fail to meet state procurement obligations should be nationalized. Russian President Vladimir Putin replied that such an option would be possible and might be applied under certain circumstances in the future (Interfax, March 31). Putin further noted that this prospect will be discussed during consultations with the Ministry of Defense in Sochi (Kommersant, March 31).

Indeed, Russia’s political leadership may already be pondering the introduction of new measures (including nationalization) to improve the DI sector, which, despite its glittering image, has showcased multiple fissures. Those problems became all the more visible in the past several years due to a combination of foreign economic sanctions and COVID-19 (see EDM, July 30, 2019, February 27, 2020, July 28, 2020, December 2, 2020). In an attempt to alleviate the impact, at the beginning of April 2020, Russian Prime Minister Mikhail Mishustin promised additional help to companies “of critical value to Russia’s economy and defense capabilities” (Rambler.ru, April 2, 2020). Speaking during the military-technical forum “Armia-2020”—where delegations from 90 countries assembled with more than 1,500 Russian DI companies showcasing 28,000 military products—Mishustin assured the audience that the Russian defense-industrial complex is internationally competitive in all areas, and is “capable of sustaining the toughest international competition” (Rossyiskaya Gazeta, August 23, 2020).

These defiant statements, however, sharply contrasted with other signals emanating from top-level Russian officials. For instance, Deputy Prime Minister Yury Borisov announced that Russian enterprises should start looking for alternative ways of generating income beyond seeking state economic help (which is rather limited). Specifically, he noted that issuing bonds and other financial securities would be a good solution (Rosbalt, February 20). Borisov’s declaration vividly highlighted the systemic and structural problems facing the Russian DI, which apparently can no longer be solved through massive financial injections coming from the state’s budget.

As noted by the director of the Center of Analysis of Strategies and Technologies, Ruslan Pukhov, the Russian DI contends with three significant challenges. First is the issue of import substitution, which, according to Pukhov, is being successfully solved. The second issue is diversification—developing dual-use products and goods that can be sold to civilian end users. This matter requires “huge investments and colossal organizational work and marketing efforts,” which, for now, remain arduous for Russia. The third and most problematic aspect is the issue of profitability of the Russian DI sector as a whole, where the majority of companies are experiencing visible financial difficulties. As a result, the lion’s share of profits generated by these companies is being paid toward interest on outstanding loans. This, in turn, leads to average profitability hovering around 4–5 percent of total revenue—an intolerably low level in comparison with Russia’s foreign competitors that demonstrate profits of around 20 percent (Theworldnews.net, September 10, 2019).

In the fall of last year, the military-focused media outlet Yezhenedelnik Zvezda carried a particularly penetrating and detailed piece systematically analyzing the problems facing Russian DI firms (Yezhenedelnik Zvezda, September 29, 2020):

• The PJSC Motovilikha Plants (Motovilikhinskiye Zavody PAO)—a metallurgical and military equipment manufacturer, specializing in modern artillery production, which joined NPO Splav, a Rostec company in 2016—has been wrestling with its financial obligations. This has led to its partial bankruptcy in 2018. The unique company survives thanks to a de facto interest-free loan of 1 billion rubles (almost $13 million) received from Rostec.
• The famous “Tankograd” (the Chelyabinsk Tractor Plant) seems unable to cope with financial hardship and suffers from “poor management and unprofessional leadership.”
• The Voronezh-based “Elektropribor” factory, specializing in repairing aircraft and developing certain parts of the Kh-47M2 Kinzhal nuclear-capable air-launched ballistic missile (ALBM), is apparently teetering on the brink of bankruptcy. Local sources claim the factory—which employs 600 highly qualified professionals wielding unique skills and knowledge—is now using only a fraction of its industrial capacity and is unable to cover its financial arrears (Riavrn.ru, February 4, 2021).

The Yezhenedelnik Zvezda article additionally points to two other paramount challenges holding back the Russian DI sector. One of them—quite traditional for Russia—is large-scale larceny. The second problem is related to the mushrooming of various hoax schemes that involve so-called one-day firms (firmy-odnodnevki). According to the research, the most notorious case involved Moskapstroy LLC, a contractor in the development of the RS-28 Sarmat liquid-fueled, super-heavy intercontinental ballistic missile, which led to huge financial losses and failure to deliver the weapon in a timely manner (Yezhenedelnik Zvezda, September 29, 2020).

It is particularly notable that the article—published in a conservative outlet that specifically promotes the interests of the DI—calls for urgent measures to increase the economic effectiveness and profitability of Russia’s defense contractors. Without such drastic actions, the piece argues, the Russia DI sector may come to resemble its Soviet predecessor, whereby a cumbersome and unprofitable “oboronka” (DI) gobbled up all available economic resources, ultimately breaking the back of the ailing Soviet economy. The main recommendation of the article’s author is for the Russian DI to increase its output of civilian products, which is not a “panacea” but a first step in the right direction.

Nevertheless, mainstream Russian media sources—coupled with the rhetoric emanating from the Kremlin—promote an entirely different solution. Picking up on Putin’s remark about nationalization, these outlets argue that “the larger the state procurement plan […] the greater the role of the government [in DI]” and the more this contributes to state security (RT, April 2). Other experts have contended that the relationship between the DI and the state should not be loosened due to the invaluable “geopolitical function” Russian arms exports play—a consideration that outweighs the economic calculus. According to a piece in Vedemosti, “[T]he mechanism of Russian arms export is an integral part of the world multi polar system,” since “the main importers of our [Russian] weaponry are countries eager to conduct sovereign foreign and defense policy.” Thus, this is one of the main ways of undermining the global hegemony of the United States (Vedomosti, October 23, 2020).

With Russia’s conflict with the West growing and deepening, Moscow—rhetoric about “remembering Soviet mistakes” notwithstanding—is increasingly resorting to Cold War–era practices in various domains. Economics and policies involving the defense-industrial complex are no exception.

*To read Part Two, please click here.