US Has Failed To Counter Russia's Import Substitution Strategy

Putin demanded that the securities of fast-growing high-tech companies be placed on the Russian stock market and in investment platforms to promote their growth. And although very late to the game, a Russian joint company is building out the country's first fifth-generation (5G) core network to substitute Ericsson, Nokia and Huawei.

Russia is not pursuing these objectives to amplify pre-existing industries with AI capabilities. It is doing this out of necessity.

Since the start of the war, it has found indirect methods of buying Western technologies despite sanctions and import bans. Indeed, in 2023, Russia imported close to US$2 billion worth of US and European chips through third parties such as China and Turkey.

American and European authorities are working to plug these holes with new sanctions packages that target dual-use goods and compel these third parties to respect Western restrictions, though since these efforts began in earnest last June, success has been limited.

Nevertheless, Moscow understands that the pressure is mounting and that it is in its interest to produce advanced technologies domestically. The president of the Russian Academy of Sciences, Gennady Krasnikov, explained in an interview this month that sanctions are an incentive for Moscow“to develop its own base of laboratory equipment and the production of consumable materials for experiments.”

Russia's 2030 Concept of Technological Development aims for“the production of high-tech products based on our own development lines using critical and end-to-end technologies.” Russia accordingly increased its production of computers, electronics, and optical products by 32.8% in 2023 compared with the previous year.

The Kremlin's domestic production incentives and mandates have spurred an import-substitution frenzy that goes beyond a willingness to detach from the West. For instance, last month, Russian scientists operating within the Kremlin's“Science and Universities” national project developed the technology to produce synthetic higher fatty alcohols, enabling Russia to avoid expensive purchases from Southeast Asian countries.

Other efforts include the“Land for One Ruble” program, introduced in March 2022 to encourage the creation of industries that align with the nation's import substitution strategy. In Moscow Oblast, about 80 projects, most of them related to the construction of new production sites, are expected to be completed before the end of this year.

Russian companies attempt to build these sites with the most modern technology, probably relying at least in part on Western imports in the short run. Alexander Shokhin, president of the Russian Union of Industrialists and Entrepreneurs, affirmed this month that import substitution“rests on a new technological base.”

Last December, the US Treasury Department noted that Russia has“struggled to access key inputs needed for its war due to US and partners' sanctions and export controls that limit its access to key technologies.” Therefore, since Russia's only long-term alternative is to“domestically manufacture these advanced weapons,” according to the Treasury article,“the United States and its partners are taking actions to help ensure that it never does.”

The problem, however, is that Russia has found ways to continue importing crucial technologies through third parties, most notably China, while solidifying its import-substituting industry at home.

This means that the short-term pain that Russian citizens have sporadically felt over the last two years when a Western company stops sending a specialized product to Moscow will subside because Russia will eventually have its own domestic equivalents.

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It can afford to heavily invest in these equivalents because it is receiving a steady profit flow by circumventing Western sanctions. The cycle persists until production independence is achieved.

However, a key obstacle to Russia's plan of self-sufficiency will be its economic reliance on China.

Although Putin claimed during his recent interview with Tucker Carlson that Russia's trade turnover with China is“balanced” and arranged so that both sides“complement each other in the high-tech sector, in the energy sector, and in the field of scientific research,” Moscow's exports to Beijing are still disproportionately composed of natural resources that China has enjoyed buying at a discount.

Meanwhile, Beijing has injected manufactured and industrial goods into Russia's economy. Eventually, Russian manufacturers using Chinese alternatives as bandages in the transition from Western imports to domestic production will want to compete with these goods.

But history has shown that it is extremely difficult to compete with Chinese prices, and on top of that, such competition will provoke undesired political friction during a time of economic rapprochement.

If Washington wants to weaken Russia's war effort and long-term economic growth, it must implement more rigorous enforcement mechanisms when devising sanctions with European allies to squeeze shut the third-party loophole that has kept the Russian economy healthy enough to invest in massive import-substitution projects.

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