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Monday, October 3, 2022
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CommunityOn the Economic Consequences of the Russia-Ukraine War

On the Economic Consequences of the Russia-Ukraine War

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By Dr. Dimitrios S. Pachis

The Russia-Ukraine war is a major economic shock to the world, and for geopolitical reasons it will have long and unpredictable economic consequences. Economic activity in Ukraine is at a standstill. Actual or threatened economic sanctions on Russia have already shattered businesses and entangled nations, with producers and consumers across the globe feeling the pinch of higher prices for oil, natural gas, precious metals, wheat, and other commodities. Large and small businesses, including producers, high tech firms, commercial and investment banks, and suppliers will suffer losses according to the degree of participation in the markets of Russia and Ukraine. For many foreign suppliers of goods and services to the two nations the war is ruinous. The price of fresh produce in Turkey dropped by 50 percent because sales to Russia and Ukraine were interrupted. An Irish company leasing commercial aircraft to airlines in Russia may suffer large losses. In addition, investors will suffer because of the decline in the currency exchange rates of the combatants, especially the Russian ruble, and the drop in the bond and stock markets.

We live in the globalized economy of the 21st century in which almost every traded product or service has a world price, and every major demand or supply shock is transmitted through the system instantaneously. There are world prices for energy sources, metals, food commodities, and final products and services from cars to computer services. Supply shocks, including bottlenecks in supply chains, will tend to raise prices. Usually, wars in many poor nations around the world are like the tremors of small earthquakes. They may involve immense human suffering, but their impact on the world economic system is usually minimal, and therefore are routinely ignored. Though rare, wars involving major economies resemble major earthquakes with intense shocks, tectonic shifts, and tsunamis.

While the war continues and long after its end, it will be foolhardy to attempt any forecast of its long-term economic consequences. It is true that the immediate combatants suffer economic losses, and even the winners in the battlefield might become losers in the longer term. Nonetheless, there are ways to analyze economic consequences of the war without pretending to have a crystal ball for every future war-related event. The first guide in our analysis is Thucydides, the historian and general from ancient Athens who explained that Sparta started the war against Athens because it feared its growing economic and military power. Fear as the major human motivation goes beyond decisions about war and peace. Wars increase the level of uncertainty and insecurity. Inevitably, fear becomes a powerful determinant of economic decisions.

As soon as prices begin to rise, buyers engage in buying behavior to hedge against further price increases. They sign contracts for the future, and stockpile commodities and products. Speculators are a particular breed of market participants that thrive on the uncertainty and fear caused by wars and any other type of instability. At the height of the oil crisis in the 1970s, speculators kept tankers full of oil away from the ports to extract the highest profit possible. Today, speculators may be betting on discounted bonds from Russia and Ukraine.

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Russia and Ukraine combined represent 29% of worldwide wheat exports, and wheat prices will continue to rise beyond the end of war. The two countries are also major producers and exporters of fertilizer that affects the cost of food production. Food inflation has the potential to destabilize countries, especially the net food importing nations. Fear prompts governments to take steps to ensure that rising prices do not cause domestic political instability. An increase in the price of bread alone could be a trigger to challenge the legitimacy of governments in poor nations. Riots and uprisings follow rapid increases in the price of food or fuel. To minimize popular discontent, governments in Europe started providing subsidies for heating oil and electricity. The coordinated release of petroleum reserves serves the same purpose. When the price of energy rises so does the cost of freight, transportation, fertilizers, and foodstuffs. Many analysts go as far as using the price at the gas pump as a barometer of the success or failure of political parties and presidents.

Countries that have strong economic links to Russia and Ukraine are scrambling to find alternative trade partners or are refusing to participate in economic sanctions against Russia, as is the case of Turkey which gets one third of its energy supply from Russia. Russia and Ukraine are major markets for Turkey’s exports, and Turkey welcomes millions of visitors from Russia and Ukraine each year. The war’s reverberations in the tourist market of Mediterranean countries means greater competition and less revenue for all.

As the social and economic fabric of Ukraine is tattered by the war, we know that individuals and nations will try to limit the damage to themselves, and if possible, derive some economic benefit from it. Already, we see companies lining up to make some profit from the sale of military hardware and services. Stock prices of such companies are rising against a weak stock market. Companies will also be angling for a share of business when Ukraine begins its reconstruction. The streams of refugees leaving Ukraine might fill labor shortages in western European countries, as in the case of Germany which faces a shortage of 300,000 to 400,000 trained workers each year for the foreseeable future. It’s in human nature to see the silver lining in the calamity of your neighbor.

Immediately after WWI, a young British economist by the name of John Maynard Keynes suggested that the way to reduce the chances of future wars in Europe caused by the enduring cynical traditions, clash of values and power politics was to create an equitable, effective, and integrated European economic system. It took many decades after WWII for European countries to pursue some form of integration because the process was undermined by provincialism and domestic political opportunism. Members of the European Union (EU), acting alone, attempt to exploit each other in every conceivable way. Examples of narrow and short-term self-interests abound. In the Libyan civil war, France and Italy find themselves on opposite sides to gain influence and business contracts. Germany exploits neighborly tensions to sell its submarines and military hardware to both Greece and Turkey. Britain’s exiting the EU to pursue its dream of becoming a global power has undermined European integration further.

Wars on the European continent and its neighboring regions are the result of the failure of major European powers to pursue economic and political integration. The EU failed to deal with the disintegration of Yugoslavia and the Libyan and Syrian conflicts in its neighborhood. The influx of Syrian refugees contributed to increased authoritarianism in the continent and fueled the anti-EU sentiment in the UK. The approach to the Russia-Ukraine war by individual EU members demonstrates the folly of opposing economic and political integration. At the start of the war Germany announced that it would allocate a one-time sum of 100 billion euros (approximately $113 billion) to strengthen its armed forces. Other European nations followed suit promising increased military spending. Raising military spending means fewer resources for development and social spending and going even deeper into debt. For example, Greece, which has the second highest public debt in relation to the size of its economy in the world, is spending billions of dollars to purchase more armaments.

Military conflicts could also exhaust warring parties spiritually, militarily, and economically, indicating that wars are rarely rational acts as many experts profess them to be. This war, as all previous wars, will change the economic balance among and within nations. An isolated Russia will not be able to innovate and compete internationally in fields of high technology. Its excessive spending on the military campaign will produce economic dislocations, domestic inflation, and public discontent. Well-connected individuals will enrich themselves in the new economic landscape. Conceivably, Russians that control the export of energy will be able to use their petrodollars or their Chinese petroyuans to amass more wealth in a depressed Russian market. Short of a nuclear catastrophe, the rest of humanity will shoulder the cost of the war by paying more and buying less.

The optimists can hope that further European economic and political integration will have a chance to deter conflicts within the family of European nations (Russia, Belarus and Ukraine included) and in the neighboring regions. Without visionary and tireless effort to complete the European economic and political integration, the advocates of peace through military strength alone will carry the day, to prove once again that war is humanity’s unstoppable destiny.

 

 

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