Europe should be concerned about the economic impact of the war in Ukraine
We don’t know if a Russian invasion of Ukraine will materialize. We only have the dramatic warnings from Washington and the less exciting reports from Germany and Kiev itself.
If there is a war, there will be major economic consequences for the rich world – where markets have seen strong growth in the wake of the pandemic, but where severe inflationary pressures have emerged – but also for emerging markets. and poor countries still trying to recover.
The consequences will be felt first in the reactions of financial and commodity markets to an invasion, then through the disruption of energy supplies due to the conflict and the subsequent economic sanctions against Russia. Among the imponderables are the reaction of China and the risks of a parallel crisis involving Iran.
The last energy shock dates back nearly half a century. In 1974, the OPEC oil cartel, led by Saudi Arabia, imposed an embargo on countries that supported Israel in the Yom Kippur War. The price of oil rose from $3 to nearly $12 a barrel. Then, in 1980, Iraq invaded Iran. The price of oil rose to $35 (equivalent to $110 today). The world has experienced a painful combination of inflation and recession.
Oil is no longer as central to the global economy and the United States is the biggest producer, thanks to shale gas. Nevertheless, Russia supplies just over 10% of the world’s supply and satisfies a third of the EU’s crude oil demand. Russia is also the world’s second largest producer of natural gas after the United States; supplying about 35% of European gas; and holds a third of the world’s reserves. The federation is also a key exporter of other essential raw materials: 40% of the world’s supply of palladium (used in catalytic converters) and 30% of titanium (used in aerospace), aluminum, nickel, copper, platinum, potash and phosphate.
This is a terrible time to have an energy-fueled economic shock, as Putin will have calculated. Oil prices are already hovering around $90 a barrel. Average natural gas prices at the December peak were $200 per MWh, about three times the pre-pandemic level. EU storage is less than 35% full. The UK is virtually out of storage after the extraordinary decision in 2017 to close our largest factory, off the Yorkshire coast.
The two worst scenarios are that Russia uses its pipeline as a “weapon” in war, or that the pipeline is disabled in combat. But Russia will not want to destroy its reputation as a (reasonably) reliable supplier to Europe. If supplies to the west are interrupted, China is ready to absorb as much gas as Russia can supply (and will therefore need less liquid natural gas from the Middle East). However, this is an area where significant price changes could come from a modest drop in supply.
The West is also threatening to sever Russia’s ties with the international payment system (Swift), which would undoubtedly harm Russia greatly. But such a move would also harm Western counterparts. Moreover, stock markets are already jittery with the threat of rising interest rates. The war could trigger investor panic, with unpredictable consequences for the stability of the financial system.
Economic circumstances also explain why Germany leads the quest to avoid war. It has little room for maneuver on energy supplies, having closed the coal and nuclear options. It depends on Russian gas but cannot use the new Nord Stream 2 gas pipeline, which bypasses Ukraine, because this pipeline is part of the Western sanctions package. Germany is also currently experiencing one of the weakest post-pandemic recoveries and a very un-German consumer inflation of 5%. Scholz is nervous.
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Brits should be nervous too. There is a crisis in living standards and a potential economic downturn in prospect, even without the possibility of a European war. According to the Bank of England, real after-tax wages have been the hardest hit in 70 years. Even after the promised £200 loan to help households pay their energy bills, there will be a 40% rise in energy prices this year. The poorest fifth of the population spends 10% of their income on energy compared to an average of 4% for British households. The war will aggravate this bad situation.
The government should be willing to revisit the Universal Credit stimulus and drop the ill-timed National Insurance increase. To pay for this largesse, a UK tax on the windfall profits of (global) oil companies would be popular, although a tax on share buybacks would be more practical and better targeted.
Fundamentally, Sunak’s promise to Tory MPs to save money now for a pre-election tax cut seems woefully inappropriate and cynical in the face of today’s real hardships. But, as with Ms Truss’ Margaret Thatcher impersonation, policy choices are driven by the specter of a future Tory leadership race, not the prospects of hardliners in Britain or poor Ukrainians.
Sir Vince Cable is the former leader of the Liberal Democrats and served as Secretary of State for Business, Innovation and Skills from 2010 to 2015.