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Can Russia Be Crushed Without Crushing Europe?
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“These sanctions that are being imposed are akin to a declaration of war, but thank G-d it has not come to that.”
—Russian President Vladimir Putin, speaking to a group of Aeroflot flight attendants at a training center near Moscow this past weekend.
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here is a laundry list of requests that the embattled Ukrainian government, under fire by Russian war machinery, has made of Western powers. Some they are almost certainly not going to get. For example, a no-fly zone over Ukraine to keep Russian planes from bombarding Ukrainian cities and the Ukrainian military has been ruled out by NATO. There’s a very simple reason. A no-fly zone requires a willingness to shoot down the other side’s planes if they violate the order. If NATO shoots down Russian planes, that means NATO and Russia will immediately be in a war themselves. The US and European countries, however, have been willing to do a lot for Ukraine, including sending weapons. But perhaps the most devastating thing they’ve done—which Putin called “akin to a declaration of war”— was to put in a massive sanctions regime that struck at much of the Russian economy, as well as at the pocketbooks of the oligarchs around him. Sanctioning the Russian Central Bank and a swath of other banks, as well as cutting off other banks from the financial messaging system SWIFT, has made the Russian economy vulnerable as well, with few outlets to the outside world. The sanctions have also had myriad knock-on effects. The Russian stock
market was shut down for an entire week. Many Russian airlines may lose their planes as the Irish leasing companies that own them demand them back. Mastercard and Visa stopped processing foreign payments for Russian issuers. The largest shipping companies in the world will no longer service Russia. And so on and so on. But part of the question around the sanctions is how much they might impact the rest of the world. The US doesn’t have much trade with Russia, but those who have been to a gas pump recently will realize that anything that affects a big oil producer like Russia— even though the sanctions don’t target oil transactions specifically—may have effects outside the country. More worrisome than the effects on the US may be the effects on Europe, which has closer ties to Russia and is reliant on Russian energy exports. Many of the compromises in the sanctions that were placed on Russia were undoubtedly due to European concerns— such as the fact that the sanctions didn’t affect energy or grain exports. So how much will the sanctions hurt Europe? And how badly can Russia be hurt without damaging Europe? To get a clearer view on this, we interviewed Zach Meyers, a senior research fellow at the Centre for European Reform, an independent think tank that examines ways to make the European Union work better. Mr. Meyers, in particular, has been examining issues related to economic decoupling, separating the economies of the European Union from outside economies.
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Some EU member states are also talking about other trade-disruptive measures like banning Russian ships from European ports, a measure the UK has taken. And most international trade is in US dollars, from which some of the largest Russian banks have been cut off.
Zach Meyers Senior Research Fellow at the Centre for European Reform Beyond grain and energy, how intertwined are the EU—or larger European, if you’d rather—and Russian economies? How much are the sanctions affecting them? They are quite intertwined, but the relationship is asymmetrical. The EU is Russia’s largest trading partner and has been heavily dependent on access to European trade, finance and capital markets, whereas the EU is not as exposed to the Russian economy; Russia accounts for 1 to 2% of EU trade. EU exports to Russia mostly include machinery and transport equipment, such as in the car industry, where many Western companies have vowed to stop trade; medicines, which can continue; chemicals; and various manufactured goods. EU imports from Russia beyond energy and grain are mostly other raw materials, some of which are important parts of the overall supply chain for European manufactured goods. I would expect to see almost all trade— leaving aside food and energy—disrupted. Many firms are now avoiding all trade with Russia because of the costs of complying with sanctions, the risks of getting sanctions laws wrong, the business risks associated with Russian counterparties, and the general public relations concerns associated with trading with Russia.
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Right now, energy and grain transactions are not sanctioned, as I understand. How do the sanctions against banks, including the Russian Central Bank, complicate Europe’s ability to get the energy and grain it needs? They will complicate it in two ways. First, as noted, many firms are shunning trade with Russia even where it is allowed by the sanctions. For example, many US firms have shunned Russian oil in recent days even when it is selling at large discounts, and many tech firms and payment services have banned all services to Russia, which go beyond the strict terms of sanctions. Second, the sanctions mean that it is difficult for Russia to do anything with the foreign reserves it accumulates. This may impact Russia’s willingness to continue to supply gas, food crops and fertilizers to Europe. However, there are two reasons why trade in energy, at least, will continue:
The sanctions have already caused massive economic damage in Russia thanks to interest rates more than doubling, rampant inflation, and the devaluation of the currency.
First, it remains extremely important to Europe. Yesterday, German Economic Affairs Minister Robert Habeck made it clear that Germany would not agree to ban imports of Russian gas. The other sanctions have been designed specifically to allow this to continue—e.g., the Russian banks that manage energy transactions, such as Gazprombank, are not excluded from SWIFT. Second, Russia cannot afford to turn off the taps. Once Europe adapts to not needing Russian gas imports—for example, with heavy green investment—there will be no going back, so Russia’s leverage over Europe will be permanently impaired. Russia’s best bet is to keep going with its existing strategy of trying to delay the green transition in Europe for as long as possible. In regard to the sanctions, how do you see the balance of power? How badly can Europe hurt Russia without overly damaging European economies? Europe clearly has the balance of power, particularly when so many other countries around the world are behind Europe and adopting the same measures. [Before the war,] 36.5 percent of Russia’s imports came from the EU, and 37.9 percent of its exports went to the EU. The sanctions have already caused massive economic damage in Russia thanks to interest rates more than doubling, rampant inflation, and the devaluation of the currency, all of which means that everyday Russians will be immediately worse off. Russia can prop up domestic companies in the short term, and it is forcing companies to convert most of their foreign currency earnings to rubles to help prop up the currency. But the long-term impacts will be even worse, with export bans making it very difficult for Russia to diversify its economy as most of the rest of the world stops buying its oil, gas and coal. The US has applied similar export bans against the Chinese firm Huawei for some years now, suggesting these types of sanc-
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large write-downs of their investments, or are now trapped with large business losses. All signs are that Europe can cope with this damage, in particular if it is prepared to delay the return of post-COVID fiscal rules to allow more scope for public funds to help individuals and businesses cope with disruption and fund the energy transition. This also assumes that some gas trade continues in the short term. Some early models therefore project that European GDP will only be marginally affected. Russia, on the other hand, will find a much higher proportion of its trade disrupted, with fewer alternative options for trading partners, leading to a significant decline in GDP.
tions could be in place for a substantial period of time. Europeans will be worse off, too, in several ways. It will take some time to understand the damage to European economies; Russian imports are likely to be embedded in different supply chains in ways not fully understood when the sanctions were imposed. In some cases, the impact may be temporary disruption as supply chains are reworked and costs might rise. In other cases, European industry may struggle to find alternative supply sources, which could have a greater impact. We also do not yet fully know if and how Russia may apply countermeasures and the extent to which European traders will self-sanction, and therefore exactly how much damage to the European economy these sanctions will cause indirectly. The other direct impacts to Europe are
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easier to identify now: Exporters to Russia will be hit—for example, carmakers and luxury brands that export to Russia. Energy costs will inevitably rise due to Europe fast-tracking efforts to reduce purchases of Russian gas—particularly in countries reliant on Russian gas. Some of those, such as the Baltics, might be prepared to bear these costs because they feel the most immediately threatened by Russia. Others, such as Germany, will put up stronger resistance. These costs will be much greater if Europe or Russia turn off the taps completely. There would be direct pain for everyday households that need gas for heating, but it would also significantly impact Europe’s industrial capacity. The EU provided 75 percent of Russia’s foreign direct investment. Foreign investors in Russia have either left, suffering
Is there a sanctions method you believe lawmakers should be considering if they want the sanctions to be successful and also less injurious to Europe? The tool that seems underused, in my view, is targeted measures against individuals associated with the Kremlin. All signs are that Putin is prepared to watch most Russian people become increasingly impoverished to achieve his vision for Russia. Europe has little idea of how likely it is that Putin will be removed, but it causes very little overall economic harm to Europe, compared to alternative sanctions measures, to crack down on Putin’s associates and limit how far they can benefit from his regime. The West has been adding more individuals to these targeted measures in recent days. But the actions are too limited and too slow—for example, the UK has only sanctioned a handful of individuals—and some of the new rules to make asset ownership transparent could take up to 18 months to implement, giving elites plenty of time to sell their assets and invest elsewhere. It is also essential that Europe continue its crackdown on “dirty money”—committing to asset and financial transparency, tackling tax evasion both internal and
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external to the EU, putting proper rules in place for political funding, and eliminating inappropriate “golden passport” schemes. Although the EU has tried to implement many of these reforms, progress has been slow, and some governments have wanted to continue to benefit from an influx of money connected to the Russian elite. Hopefully, the invasion will at least pressure many of these governments to treat these issues as a priority. Is there any other aspect of this issue that you think it is important to understand? First, I would emphasize that enforcement of sanctions is critical. In many cases in the past, sanctions have made little difference, and the West has not dedicated anywhere near enough resources toward investigating and prosecuting breaches. Over time, if enforcement is lacking, some individuals and firms will stop taking the sanctions seriously, or they will find workarounds. The West’s sanctions strategy partly reflects this by combining both “shock and awe” sanctions and those that will impact Russia’s economy more slowly and over the long term—e.g., technology trade bans. But proper investigation and enforcement will nevertheless be important to ensure that the sanctions are as effective as possible. To a large extent, Russia’s ability to tolerate sanctions will depend on the extent
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European exporters will be hit—for example, carmakers and luxury brands that export to Russia. And energy costs will inevitably rise. to which China is willing to support the Russian economy. I am not at all confident it will be: First, in the short term, Chinese banks have been unwilling to step in and bail out Russian businesses for fear of falling foul of US sanctions and thereby losing access to US dollar transactions. China can probably develop tools to avoid these consequences, but this will take time. China is taking steps to ensure it does not become as dependent on Russian gas as Europe is, and it will drive a hard bargain knowing Russia has no other buyers. So Russia will still be worse off, though China will want to take into account not causing too much instability in its
northern regions. Furthermore, due to the location of gas fields and pipelines, China cannot simply step in to buy gas otherwise destined for Europe. In technology, China will probably want to keep Russia “contained” as a junior partner rather than as a partnership of equals. This may be hard for the Russian leadership to bear in the long run, which may—in the very long run—drive it back toward Europe. Finally, in the long run, some of the more severe sanctions—such as freezing central bank reserves—weaponize countries’ interdependence. It is difficult to criticize the sanctions in the short term, but this will have long-term implications that will leave everyone worse off, by leaving many countries less willing to rely on Western finance, fueling the growth of alternative payment networks that the West does not have oversight or control over, and contributing to broader economic decoupling, undermining many of the welfare gains of globalization. One way the West can help mitigate this damage is by being clearer about the circumstances in which the most severe sanctions—such as central bank asset freezes and exclusion from financial systems—will be deployed in the future. That should both improve their deterrent effect and help alleviate concerns about such sanctions being used arbitrarily or simply against “geopolitical rivals” in the future.l
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