There are no good choices for the west on Ukraine

Economy News

Evil exists. It sits in the Kremlin consumed by resentment and lust for power. It marches into a country whose crime was to dream of freedom and democracy. How is such evil to be defeated? Might economic sanctions, combined with the resistance of the Ukrainian people, force Vladimir Putin into retreat? Or might they even lead to his overthrow? Alternatively, might he risk escalation up to use of nuclear weapons?

Beyond doubt, the sanctions the west has used are powerful. Putin has even called them “akin to an act of war”. Russia has been largely cut out of the global financial system and more than half of its foreign reserves have been rendered useless. Western businesses are frightened of continuing to engage with Russia, for reputational and prudential reasons. Neil Shearing, chief economist of Capital Economics, forecasts a peak-to-trough fall in gross domestic product of 8 per cent, followed by a lengthy period of stagnation. The jump in the central bank’s interest rate to 20 per cent will on its own be costly. Shearing may well be too optimistic. (See charts.)

Restrictions on energy exports are an obvious next step, as the Biden administration argues, against German opposition. It is, to say the least, objectionable that the high energy prices caused by Putin’s crimes also finance them. The Ukrainian economist Oleg Ustenko has argued strongly for such a boycott. Harvard’s Ricardo Hausmann proposes a neat alternative: a tax of 90 per cent on Russia’s exports of oil and gas. Since supply elasticity is low, he argues, the costs would fall on Russian producers, not western consumers, and so scarcity rents would also be transferred to the latter.

Line chart of Cumulative change since Oct 1 2021 showing Sanctions have bitten the Russian economy devastatingly hard

On feasibility, Hausmann argues that in 2019, 55 per cent of Russia’s exports of mineral fuels went to the EU, while a further 13 per cent went to Japan, South Korea, Singapore and Turkey. If all these countries agreed to tax its oil, Russia might try to sell it elsewhere, especially to China. But how much would China take, given the logistical challenges and risk of western retaliation of some kind?

A big question is how well the world could cope with the energy adjustment. An analysis by Bruegel concludes that “it should be possible to replace Russian gas already for next winter without economic activity being devastated, people freezing, or electricity supply being disrupted”, though this would take a determined effort. With Hausmann’s import taxes, oil and gas prices in the rest of the world should even fall.

Bar chart of Share of Russian exports, 2021 (%) showing Oil, oil products, gas and diesel are 60 per cent of Russian exports

The purpose of sanctions is, however, to change policy and possibly even the regime in Moscow. Is this feasible? Experience suggests that breaking an autocratic regime willing to impose huge costs on its people is hard: Venezuela is a recent failure. Against this, one can point to the fact that Putin has not mobilized the Russian people for a long war against Ukraine and the west. He even euphemistically called it a “special military operation” against “neo-Nazis”. These lies might start to unravel. Yet, as Sergei Guriev, an economist of Russian origin who teaches at Sciences Po in Paris, noted in a dialogue with Princeton’s Markus Brunnermeier, Putin is moving from a dictatorship of spin to one of fear. So long as his entourage stays loyal, he may well retain power, however badly his war goes and however painful the sanctions.

Line chart of Russian share of global output (%) showing Russia is a large producer of oil and natural gas

Broad sanctions of this kind are a double-edged weapon, since they work by imposing significant costs on ordinary people. Among the biggest losers will be the aspiring middle classes. The regime might find it easy to convince the victims that their pain merely proves western hostility. So, yes, some Russians might blame Putin. But, especially given Putin’s control over the media, a huge number might blame the west, instead.

Line chart of Russian share of global oil and gas exports (%) showing Russia is a giant in exports of natural gas and oil

The evidence on the performance of sanctions is also depressing. Dursun Peksen of Memphis university offers these conclusions: aim for major and immediate damage to the target economy; seek international co-operation; expect autocracies to be more resistant to sanctions than democracies; expect allies to be more responsive than enemies; and, finally, expect sanctions to be less effective in achieving large objectives than modest ones. The west is in good shape on the first two points in this list, though curbs on energy exports might be needed for the first and co-operation with China for the second. But it is dealing with a hostile autocrat and also trying to reverse a war he considers a vital national and personal interest. Omens for success do not look good.

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It is also possible that successful support for the Ukrainian resistance, combined with sanctions that inflict huge costs on Russians, without ending the regime, might make Putin willing to take even more desperate risks. This could even include resort to use of weapons of mass destruction against Ukrainian or other targets further west.

Line chart of showing The price of oil and wheat has jumped and that of natural gas has soared

In retrospect, there should probably have been less ambiguity over western support for Ukrainian independence. Now, we must do everything we can to support Ukraine’s fight for survival, short of taking what seems the excessive and possibly futile risk of direct injection of NATO air forces into the war. We should strengthen sanctions, though they may ruin Russia’s economy without changing its policy or its regime. We should state that our war is not with Russian people, though they may not forgive us for the pain we are inflicting upon them. We should ask China and India to persuade Putin to end his war, though we must recognize that such an effort is highly likely to fail.

Only bad choices exist. Yet Ukraine can not be abandoned. We must go on.

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