Inflation is high and labour is in short supply, but for most Russians the war years are party time, as they have seen the largest growth in real disposable income in a decade. As of August 1, the income they have to spend on themselves, after covering the basics like food and utilities, was up a whopping 9.6% year on year, RosStat reports.

This is the first time in a long time that the rise in nominal wages has outstripped inflation by such a wide margin. The last time Russians were so flush with spare cash was in the midst of the boom years in the noughties, when Russia Inc. was earning money hand over fist thanks to sky high oil prices.

But after the sanctions regime was first imposed in 2014 following the annexation of the Crimea things went rapidly from bad to worse. Real incomes for Russians experienced a decline between 2014 and 2017 as the petro-driven economic growth model was exhausted, as detailed in bne IntelliNews’ history of Russian crises, stabilising only in 2018, when the recession came to end.

The pandemic caused another drop in incomes as everyone was forced to stay at home, leaving real incomes 11% lower by the third quarter of 2020 compared to 2013 levels. A rebound began in 2021, first due to a unexpectedly strong bounce-back from the pandemic and a year later as the military Keynesianism boost of war spending began to kick in.

Currently, the primary driver of soaring income growth is rapid rises in wages caused by a chronic shortage of labour. In a widely reported story, hundreds of thousands of men have joined the army and been sent to the front, draining the labour pool. Unemployment has fall to an all-time post-Soviet low of only 2.4% of the population.

At the same time, since Putin put the economy on a war footing, the economy has been running red hot, with growth far in excess of its economic potential, according to the CBR’s latest macroeconomic survey, that has sent inflation soaring to touch on 9% in July.

Taken separately these two problems – lack of labour and high inflation – would be major economic headaches, but taken together they offset each other to drive up nominal wages far faster than prices are rising, leaving the average Russian with a lot more spendable money that is increasing even faster than the inflation rate.

Even with inflation up to 9%, nominal wages rose by 18.7% between January to May this year, translating into a gain in real wages of 10.1%, once inflation is discounted. The average nominal wage in May was RUB86,400 ($1,008) – one of its highest levels in years and up by a quarter from the latter half of the noughties level.

A big question mark hangs over how sustainable this set up is. Putin has so far avoided imposing a general mobilisation by paying super-high military salaries that are multiples of the average wage to attract volunteers, and some 30,000 men have been signing up a month – enough to replenish the ranks in the face of heavy casualties on the front line. However, it appears over the summer that the rate of new recruits joining the fight has begun to slow, forcing the Kremlin to hike wages again. Putin more than doubled the lump-sum payment for joining the war against Ukraine at the end of July to an enormous, by Russian standards, RUB400,000 ($4,500).

High payments to volunteers have set new benchmarks for the labour market and soldiers that are earning RUB200,000 or more monthly will eventually have to return to jobs that pay the more usual RUB50,000-60,000 a month.

Having to compete with the soaring salaries in the military, firms on the home front have also been forced to dramatically hike wages, and even then are struggling to fill vacant positions.

The rapid acceleration in wage rises is obviously feeding the fire and has left the CBR desperately battling to hold it down. After hiking the prime rate to 20% immediately after the invasion, the CBR put through string of cuts to bring the rate back down to 7.5% by the end of the first year of the war, while inflation retreated to a mere 2.5% by May 2023. But as the Keynesianism effect of rising military spending took root inflation has been rising steadily and the CBR reversed its loosening policy shortly afterwards and began tightening again. At the July monetary policy meeting the CBR hiked rates by 200bp to 18% and may have to raise them again this year. The regulator has also increased its outlook for inflation to 6.5% of the full year. Inflation is not anticipated to fall to the CBR’s target rate of 4% for at least two years.

These are difficult macroeconomic problems that will be hard to solve, but for the man in the street the same problems have been driving up disposable income growth.

The Ministry of Economic Development reported a 28.4% increase in property income for Russians in the first half of the year, largely from deposits yielding around 20%. Individual account balances grew by RUB4.8 trillion, reaching RUB49.8 trillion in the first half of the year as bank interest earned on deposits was also rising faster than inflation as a result of the CBR hikes.

In the long term these distortions will eventually catch up with the people. Russia has entered a phase of high labour costs coupled with low productivity, characterised by an influx of skilled personnel into the defence industry, driven by increased budget spending.

On top of the labour shortage, the country's demographic problems and low fertility rate of 1.4, less than the 2.1 replacement rate, and anti-immigration policies are exacerbating the labour crisis. Wage growth is likely to persist even if the economy cools from overheating to stagnation due to a supply shortage.

At the July monetary policy meeting CBR Governor Elvia Nabiullina said that the Russian economy is currently a “real powerhouse” in which there is hardly any unemployment, but went on to warn: "All the resources in Russian economy are exhausted. Inflation is rising, there is an extreme lack of workers. Adding money from reserves to market will just increase inflation without bringing new growth. Russia is likely facing stagnation or deep recession in the future."

A 10% increase in real income will require businesses raising wages by 20% annually to stay competitive, amounting to an additional RUB6 trillion per year – comparable to the entire profit tax, The Bell said in a report.

The solution to this conundrum is to reverse the falling productivity of labour, but the Western sanctions on technology have cut Russia off from the most advanced electronics and machinery that could deliver those gains, and as bne IntelliNews reported, Russia doesn’t have the domestic precision tools production capacity to fix the problem on its own. Productivity must grow by at least 15% annually to cover wages increases of 20%, says The Bell, which is highly improbable.