After being wracked by the pandemic, supply chain strangles and soaring prices, the global economy is about to be set on another unpredictable course by an armed clash at Europe’s border.
Preparations for a possible Russian invasion of Ukraine have already taken their toll. President Biden’s promise to retaliate with sanctions and the potential for Russian retaliation have depressed stock returns and boosted gas prices.
An open attack by Russian troops could send skyrocketing energy and food prices, fuel inflationary fears and unnerve investors, a combination that threatens investment and growth in economies around the world.
As harsh as the impact, the immediate impact will not be nearly as devastating as the sudden economic shutdowns first caused by the coronavirus in 2020. Russia is a transcontinental behemoth with 146 million people and a vast nuclear arsenal, as well as a major supplier of the oil, gas and commodities that power the world’s factories. But unlike China, which is a manufacturing powerhouse and tightly knit in complicated supply chains, Russia is a small player in the global economy.
Italy has twice the economy with half the population and fewer natural resources. Poland exports more goods to the European Union than Russia.
“Russia is incredibly insignificant in the world economy outside of oil and gas,” said Jason Furman, a Harvard economist and adviser to President Barack Obama. “It’s basically a big gas station.”
Of course, a closed gas station can be crippling for those who depend on it. The result is that any economic damage is unequally distributed, intense in some countries and industries and unnoticed in others.
Europe gets nearly 40 percent of its natural gas and 25 percent of its oil from Russia and is likely to be hit with spikes in heating and gas bills that are already skyrocketing. Natural gas reserves are at less than a third of capacity as weeks of cold weather loom, and European leaders have already accused Russia’s President Vladimir V Putin of cutting supplies to gain a political advantage.
And then there are food prices, which according to a recent United Nations report, have risen to their highest levels in more than a decade, largely due to the chaos in the pandemic’s supply chain. Russia is the world’s largest exporter of wheat and, together with Ukraine, accounts for almost a quarter of total world exports. For some countries, the dependency is much greater. This grain stream accounts for more than 70 percent of Egypt’s and Turkey’s total wheat imports.
This will further weigh on Turkey, which is already in the midst of an economic crisis and grappling with inflation nearing 50 percent, with skyrocketing food, fuel and electricity prices.
And as usual, the burden falls heaviest on the weakest. “Poorer people spend a higher proportion of their income on food and heating,” said Ian Goldin, professor of globalization and development at the University of Oxford.
Long known as “Europe’s breadbasket,” Ukraine actually sends more than 40 percent of its wheat and corn exports to the Middle East or Africa, where fears further food shortages and price hikes could stoke social unrest.
For example, Lebanon, experiencing one of the most devastating economic crises in more than a century, gets more than half of its wheat from Ukraine.
Ukraine is also the world’s largest exporter of seed oils such as sunflower and rapeseed oil.
Analysts have worked out a range of scenarios from mild to severe. The impact on working-class families and Wall Street traders depends on the outcome of an invasion: whether Russian troops stay near the border or attack Ukraine’s capital, Kiev; whether the fighting lasts for days or months; what kind of Western sanctions will be imposed; and whether Mr Putin will respond by holding back critical gas shipments from Europe or launching insidious cyberattacks.
“Think about phasing it in,” said Julia Friedlander, director of the Economic Statecraft Initiative at the Atlantic Council. “This will likely play out as slow-motion drama.”
As the pandemic has made clear, small disruptions in a region can cause large disruptions far away. Isolated shortages and price spikes — whether in gas, wheat, aluminum or nickel — can snowball in a world still struggling to recover from the pandemic.
May 21, 2022 at 2:50 p.m. ET
“You have to look at the background against which this is happening,” said Gregory Daco, chief economist at EY-Parthenon. “There is high inflation, tight supply chains and uncertainty about what central banks will do and how persistent the price hikes are.”
The added burdens may be relatively small in isolation, but they are piling up on economies still recovering from the economic bodystrike wrought by the pandemic.
It is also clear, added Mr Daco, that “political uncertainty and volatility are weighing on economic activity”.
This means that an invasion could have a dual effect – slowing economic activity and raising prices.
In the United States, the Federal Reserve is already facing its highest inflation in 40 years at 7.5 percent in January and is expected to start raising interest rates next month. Higher energy prices triggered by conflict in Europe may be temporary but could fuel concerns about a wage-price spiral.
“We could see a new surge in inflation,” said Christopher Miller, a visiting fellow at the American Enterprise Institute and an assistant professor at Tufts University.
Inflation fears are also fueling potential shortages of key metals like palladium, aluminum and nickel, causing further disruption to global supply chains already suffering from the pandemic, trucker blockades in Canada and semiconductor shortages.
For example, the price of palladium, which is used in car exhaust systems, mobile phones and even dental fillings, has skyrocketed in recent weeks amid fears that Russia, the world’s largest exporter of the metal, could be cut off from global markets. The price of nickel, which is used to make steel and electric car batteries, has also skyrocketed.
It’s still too early to assess the exact impact of an armed conflict, said Lars Stenqvist, chief technology officer at Swedish truck maker Volvo. But he added: “It’s a very, very serious matter.”
“We have a number of scenarios on the table and are following the developments of the situation day by day,” Stenqvist said on Monday.
The West has taken steps to mitigate the impact on Europe should Mr Putin decide to retaliate. The United States has increased shipments of liquefied natural gas and asked other suppliers like Qatar to do the same.
Demand for oil could give new impetus to negotiations to revive a deal to curb Iran’s nuclear program. Iran, which is estimated to stockpile up to 80 million barrels of oil, has been locked out of many world markets since 2018, when President Donald J. Trump withdrew from the nuclear deal and imposed sanctions.
Some of the sanctions against Russia that the Biden administration is considering, like cutting off access to the international payment system SWIFT or blocking companies selling anything with American-made components to Russia, would hurt anyone doing business with Russia. But overall, the United States is much less vulnerable than the European Union, which is Russia’s largest trading partner.
Americans are likely to see higher gas prices, as Mr. Biden has already warned. But since the United States is itself a large natural gas producer, those price hikes aren’t nearly as steep or as broad as elsewhere. And Europe has many more ties to Russia and engages in more financial transactions – including paying for Russian gas.
Oil majors like Shell and Total have joint ventures in Russia, while BP boasts of being “one of the largest foreign investors in Europe,” with ties to Russian oil giant Rosneft. Airbus, the European aviation giant, sources titanium from Russia. And European banks, particularly in Germany, France and Italy, have lent billions of dollars to Russian borrowers.
“Heavy sanctions that hit Russia painfully and broadly have the potential to cause enormous damage to European customers,” said Adam Tooze, director of the European Institute at Columbia University.
Depending on what happens, the biggest impact on the global economy may only become apparent over the longer term.
One result would be to push Russia towards closer economic ties with China. The two nations recently negotiated a 30-year deal for Russia to supply gas to China via a new pipeline.
“Russia is likely to shift all energy and commodity exports to China,” said Carl Weinberg, chief economist at High Frequency Economics.
The crisis is also contributing to a reassessment of the structure of the global economy and concerns about self-sufficiency. The pandemic has already highlighted the downside of widely dispersed supply chains that rely on lean manufacturing.
Now, Europe’s dependence on Russian gas is spurring discussions about expanding energy sources, which could further marginalize Russia’s presence in the global economy.
“In the long run, this will push Europe to diversify,” said Jeffrey Schott, a senior fellow who works on international trade policy at the Peterson Institute for International Economics. As for Russia, the actual costs “would be corrosive over time and really make it that much harder to do business with Russian companies and discourage investment.”