The economic impact of the war between Russia and Ukraine – Image: Xpert.Digital
The economic consequences of three years of war
Arms boom versus structural problems: Why Russia's growth is crumbling
The war between Russia and Ukraine, which began in February 2022, has not only resulted in enormous human losses but also profound and lasting economic damage in both countries. More than three years after the start of the invasion, the full complexity of the economic consequences is becoming apparent. While both economies are suffering from the direct and indirect effects of the conflict, they have developed different strategies to cope with the economic challenges.
Ukraine experienced a dramatic collapse in its economic output during the first year of the war, falling by almost 30 percent of its gross domestic product. However, it stabilized from 2023 onward and has since shown moderate recovery rates. Russia, on the other hand, initially benefited from a war-related economic boom, driven primarily by the arms industry. The Russian economy grew by 4.1 percent in both 2023 and 2024, but this growth is now slowing noticeably, and structural problems are becoming increasingly apparent.
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The Russian war economy under pressure
Slowdown in economic growth
The Russian economy is at a turning point. After the strong growth of recent years, the economy is slowing considerably. In January 2025, total economic output exceeded its level of the previous year by only 3 percent, compared to 4.5 percent in December 2024. The central bank forecasts a further slowdown to 2.9 percent for the first quarter of 2025 and expects growth of only between 1.0 and 2.0 percent for the entire year.
This development is particularly noteworthy because the growth of recent years was primarily due to the massive expansion of the arms industry. Manufacturing output rose by 8.5 percent in 2024, but this was largely attributable to the increase in arms production. At the same time, output in the mining and raw materials sector fell by 0.9 percent.
Financial challenges and structural problems
Financing the war poses ever greater challenges for Russia. Military spending already increased by 42 percent in 2024, and the defense budget passed for 2025 foresees further massive increases. At 13.5 trillion rubles, this is equivalent to approximately 145 billion US dollars, an increase of more than 25 percent compared to the previous year. This means that military spending will account for between 7 and 8 percent of Russia's gross domestic product, a record in Russia's post-Soviet history.
To finance these enormous expenditures, the Russian government is drawing on various sources. One particularly worrying development is the plundering of the welfare fund, from which the equivalent of €4.8 billion is to be withdrawn in 2025 to offset the budget deficit. This fund was originally intended for the Russian pension system, and its continuous depletion represents a significant burden on future social security.
Inflation and monetary policy as a brake on growth
A key problem facing the Russian economy is persistent inflation, fueled by war-related government spending. To combat the spiraling prices, the Russian central bank temporarily raised the key interest rate to 21 percent; it now stands at 18 percent. However, these drastic measures have had significant negative repercussions for the private sector.
With interest rates this high, small and medium-sized enterprises (SMEs) can no longer afford loans. Many consumers prefer to keep their money in savings accounts rather than spend or invest. This trend is leading to a significant slowdown in economic growth outside the defense sector and threatens to trigger a wave of corporate bankruptcies that could also affect large and key companies.
Structural transformation to a war economy
The war has led to a fundamental transformation of the Russian economic structure. The state has assumed an even more central role in the economy and abandoned its previous conservative fiscal policy in favor of higher deficits. However, this transformation brings with it significant problems.
The massive shift of labor to the arms industry, where significantly higher wages are paid, has led to an acute labor shortage in other sectors of the economy. At the same time, wage and credit costs in the private sector have risen considerably. Essential consumer goods such as butter and eggs have not only become more expensive but have even experienced temporary shortages.
The Ukrainian economy is fighting for survival
Stabilization after the initial shock
The Ukrainian economy has shown remarkable resilience after the dramatic collapse in the first year of the war. Following a decline of 28.8 percent in 2022, it was able to grow by 5.3 percent in 2023. Growth of approximately 2.9 to 3.5 percent is projected for 2024. This stabilization is all the more remarkable given that it occurred under continuous war conditions with almost daily air raids on cities and infrastructure.
Ukraine adapted quickly to the new reality. Companies relocated their production to safer western and central regions, developed alternative logistics routes, and switched to alternative energy sources. These adaptations enabled the economy to function despite the ongoing conflict.
Massive war damage and infrastructure destruction
The direct damage from the war is immense and continuously increasing. The World Bank's damage and needs assessment puts the war damage for 2024 at US$155 billion, equivalent to Ukraine's current gross domestic product. The total need for reconstruction is estimated at US$524 billion over a ten-year period, almost three times the 2024 GDP.
The destruction of the energy infrastructure is particularly dramatic. By 2024, Ukraine had only about a third of its energy supply capacity remaining. Europe's largest nuclear power plant in Zaporizhzhia has been occupied by Russian troops since March 2022. Furthermore, the occupation of eastern Ukraine brought almost all of its coal reserves and a large portion of its natural gas reserves under Russian control.
Agriculture, a traditionally important sector of the Ukrainian economy, has also been severely affected. A quarter of Ukrainian territory is mined and damaged by hostilities, much of which was agricultural land. Cultivated areas have decreased from 28.5 million hectares in 2021 to 22.5 million hectares in 2023. Approximately half of the agricultural machinery is no longer operational.
Demographic crisis and labor shortage
Ukraine is facing a severe demographic crisis that is significantly impacting its long-term economic prospects. The population has declined by approximately 10 million people, or 25 percent, since the start of the conflict in 2014, including 8 million since the beginning of the Russian full-scale invasion in 2022. The workforce has fallen from 17.4 million in 2021 to around 14 million currently.
This trend is expected to worsen. Estimates suggest that up to 100,000 jobs could remain unfilled, particularly in key sectors such as logistics, transportation, IT, construction, and agriculture. By 2033, the demand for additional skilled workers could rise to as many as 4.5 million. The birth rate has plummeted to one child per woman, the lowest in Europe and one of the lowest worldwide.
The long-term consequences of this demographic trend are serious. Even in optimistic scenarios, demographers predict a population decline of 21 percent by 2052. In the most pessimistic scenario, the population could shrink by as much as 31 percent.
Funding through international aid
Ukraine's economic stability is heavily dependent on international support. Over half of its state budget is financed from abroad. The Ukrainian state budget for 2025 projects revenues of approximately €50.5 billion and expenditures of around €85 billion. The projected deficit amounts to €35.4 billion, or 19.4 percent of gross domestic product.
The largest budget item is national defense, with expenditures of €48 billion, which is more than a quarter of the country's total economic output. In addition to these budget expenditures, Ukraine received an average of US$46 billion annually in direct military aid between 2022 and 2024.
Europe has established itself as Ukraine's most important supporter. By February 2025, Europe had mobilized a total of €23.2 billion more in support than the US. Germany alone has provided Ukraine with aid totaling almost €44 billion since February 2022. A key instrument is the ERA loan mechanism, which provides Ukraine with a total of €45 billion in loans, financed by proceeds from frozen Russian assets.
The effectiveness of Western sanctions
Comprehensive sanctions regime
Western sanctions against Russia now comprise 18 packages and are among the most comprehensive economic sanctions in history. They target various sectors of the Russian economy: the energy and financial sectors, the arms industry, and the so-called Russian shadow fleet.
In the energy sector, the price ceiling for Russian crude oil was lowered from $60 to $47.60 per barrel. The EU imposed an embargo on Russian oil transported by ship and banned the import of products made from Russian crude oil that had been refined in third countries. Additionally, 444 ships in the Russian shadow fleet were subjected to port access restrictions and service bans.
In the financial sector, 13 more banks were excluded from the SWIFT financial communication system, and transactions for three Russian financial institutions were banned. Russian assets worth over €300 billion were frozen.
Medium-term effect of the sanctions
The sanctions have certainly had an effect, although not to the extent originally hoped. Russia's economy has become significantly more vulnerable to external shocks. Should export revenues decline, the Russian central bank would sorely miss its frozen currency reserves and would be able to do little to counter a collapse of the ruble.
In the long term, Russia will suffer greatly from the fact that sanctions have made the country toxic for foreign investors. Even Chinese investors currently show no interest in long-term economic commitments in Russia, as ties with the West remain more important. The expropriation of Western companies by the Russian government has rendered the country unattractive as an investment location for a very long time.
The Shadow Fleet Challenge
A key problem in enforcing the sanctions is Russia's shadow fleet. This fleet consists of approximately 650 to 1200 ships with opaque ownership structures, which are used to circumvent the sanctions. For the past six months, the fleet has been growing by an average of 30 ships per month, three times faster than in 2024.
While in spring 2022 around 20 percent of Russian oil exports were carried out by tankers without connections to Western countries, the share of the shadow fleet now stands at 85-90 percent for crude oil. Since the introduction of the price cap, Russia has earned almost 15 billion euros in additional revenue from crude oil exports via the shadow fleet's tankers.
Operating ships in the shadow fleet is extremely lucrative. A single ship can generate $30 to $40 million in just one year, while used oil tankers cost around $12 million to buy. These enormous profit margins explain the rapid growth of the shadow fleet despite the risks.
Hub for Security and Defense - Advice and Information
Hub for Security and Defense - Image: Xpert.Digital
The Security and Defence Hub offers expert advice and up-to-date information to effectively support companies and organizations in strengthening their role in European security and defence policy. Working closely with the SME Connect Defence Working Group, it particularly promotes small and medium-sized enterprises (SMEs) that wish to further develop their innovative capacity and competitiveness in the defence sector. As a central point of contact, the Hub thus creates a crucial bridge between SMEs and European defence strategy.
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Demographics, growth, costs: Long-term consequences of the war for both countries
Strategies and measures for perseverance
Russian adaptation strategies
Russia has developed various strategies to mitigate the economic impact of the war and sanctions. The most important is the aforementioned shift to a war economy with massive state investment in the defense industry. However, this policy of military Keynesianism has reached its limits and is leading to structural distortions.
To finance the war, Russia has created a virtually secret financing plan. Since February 2022, the state has been assuming war-related loans from Russian banks through special legislation. The Russian government sets the terms for these loans, which then flow to companies that produce war materiel. These hidden expenditures are a major cause of high inflation and the resulting high interest rates.
Another important element is increased economic cooperation with China and other non-Western countries. The war has transformed Russia into a more closed economy, one that is more dependent on China. This new orientation makes it possible to procure Western technologies and goods indirectly and to develop alternative markets for raw materials.
Ukrainian survival strategies
Ukraine has made remarkable adjustments to keep its economy running under wartime conditions. The most important strategy is the spatial redistribution of economic activity. As early as 2014, production capacities began to shift from the eastern regions to the western and central regions, a process that intensified after the full-scale invasion of 2022.
Companies developed new logistics routes to circumvent the blockage of traditional trade routes. The Ukrainian maritime corridor improved logistics, although exports are expected to remain weak in 2025. Many companies switched to alternative energy sources and developed decentralized energy systems to be less vulnerable to attacks on centralized energy infrastructure.
An important aspect is the mobilization of internal resources. Despite the war, a remarkably high level of investment in the economy has been maintained, with annual growth rates of 10 to 50 percent. These figures far exceed GDP growth rates and demonstrate a strong belief in the protection of the territory and in peace.
International support measures
The international community has developed extensive support measures for Ukraine. In addition to direct financial and military aid, innovative financing mechanisms have been created. The ERA loan mechanism uses proceeds from frozen Russian assets to finance Ukrainian defense and reconstruction.
Concrete plans for reconstruction have already been developed. Ukraine estimates the total cost at more than €850 billion over a period of 14 years. Financing is to be provided through two funds: a Ukraine fund managed by Kyiv with over €460 billion from seized Russian assets, and a second fund with almost €400 billion from private investments.
Europe has taken a leading role in providing support. Germany, France, Italy, and Poland, together with the European Commission and the European Investment Bank, have launched the European Flagship Fund for the reconstruction of Ukraine. With initial capital of €220 million, the fund aims to mobilize around €500 million by 2026.
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Economic forecasts and long-term impacts
Russian economic outlook
Forecasts for Russian economic development are consistently pessimistic. International institutes expect growth of only 1.0 to 2.0 percent for 2025, compared to 4.1 percent in the two preceding years. The Kiel Institute for the World Economy even predicts only 1.5 percent for 2025 and 0.8 percent for 2026. The International Monetary Fund is even more pessimistic, expecting growth of only 0.9 percent for 2025.
This slowdown is primarily due to the Russian central bank's drastic monetary policy freeze. The high interest rates, currently at 18 percent, are stifling the economy because loans are becoming unaffordable and a wave of bankruptcies threatens, potentially affecting even large corporations.
In the long term, Russia's economic development will fall further and further behind what the country could have achieved without the war and the sanctions. Considering the lost potential economic growth, the war could even cost Russia $1.3 trillion, if one extrapolates how growth might have developed by 2026.
Ukrainian economic outlook
Short-term forecasts for Ukraine are also subdued. Economic growth of only around 2 percent is predicted for 2025 compared to the previous year. The Vienna Institute for International Economic Studies even anticipates a further deterioration of the economic outlook, mainly due to the destruction of critical infrastructure and the worsening labor shortage.
Even under optimistic assumptions, real GDP in 2025 is expected to be around 20 percent below the pre-war level of 2021. A return to pre-war levels is not anticipated until 2033 at the earliest. Overall, the Ukrainian economy is expected to remain 17 percent below its pre-war level in real terms in 2026.
However, the long-term consequences are even more serious. The demographic crisis will shape Ukraine for decades. The population has fallen from 51.9 million in 1991 to approximately 37.6 million in 2023. If one considers only the government-controlled territory, the figure is even lower, at just 32.6 million.
Reconstruction as an opportunity
Despite the enormous challenges, the planned reconstruction of Ukraine also offers opportunities for sustainable economic development. The reconstruction concepts rely heavily on renewable energies and green technologies. Cities like Trostianets in the Sumy region aspire to become green model cities and to completely convert their energy supply to renewable sources.
Ukraine possesses significant potential for localizing production capacities in green value chains such as solar energy, wind power, and battery technology. The combination of domestic raw materials, a skilled workforce, and EU demand could contribute to economic recovery and integration into European supply chains.
The European Bank for Reconstruction and Development has unveiled a facility to mitigate the risks of renewable energy in Ukraine, designed to protect investors against price fluctuations in the Ukrainian electricity market. Such instruments are crucial for mobilizing private investment in reconstruction.
The economic resilience of both countries
After more than three years of war, both economies are showing resilience as well as structural weaknesses. Russia initially benefited from a war-induced economic boom, but now faces significant structural problems. The shift to a war economy boosted growth in the short term, but hampered long-term growth targets and created an imbalance in the economy.
Ukraine has demonstrated remarkable adaptability after the initial shock and has stabilized its economy. However, it remains heavily dependent on international support and faces enormous demographic and infrastructural challenges.
Both countries can sustain the war economically for some time, albeit at very different costs. Russia has larger financial reserves but suffers from the structural distortions of a war economy and increasing international isolation. Ukraine is more vulnerable but receives continuous international support and has already adapted its economy to wartime conditions.
In the long term, the war will incur enormous costs for both countries. For Russia, this means increasing isolation from the global economy and structural problems that will persist for years after the war ends. For Ukraine, it is about nothing less than the complete reconstruction of the country under entirely new demographic and economic conditions. International support will be crucial not only to stabilize Ukraine but also to modernize it sustainably.
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