Shockwaves hit the global economy, with serious risk for Europe

Russia’s invasion of Ukraine and the continued effects of the pandemic have hit countries across the world, but the series of crises has hit Europe hardest, causing the sharpest jump in energy prices, one of the highest inflation rates and the biggest recession risk.

The aftermath of the war threatens the continent with what could be its most challenging economic and financial crisis in decades, as some fear.

Neil Shearing, chief economist at Capital Economics, says that while growth is slowing around the world, in Europe it is more serious due to a more fundamental deterioration. According to him, real incomes and living standards are falling, with the EU and Britain the worst off.

Several countries, including Germany, the region’s largest economy, have been dependent on Russian energy for decades. The eightfold increase in natural gas prices since the start of the war poses a historic threat to European industrial might, living standards, peace and social cohesion. Plans for factory closures, blackouts and rationing are being drawn up in case of shortages this winter.

Ian Goldin, professor of globalization and development at the University of Oxford, says the risk of falling incomes, rising inequality and growing social tensions can lead to a fractured world. “We haven’t faced anything like this since the 1970s, and it’s not going to end anytime soon,” he says.

The pressure also affects other regions of the world, but some of the causes – and the perspectives – are different. In the US, higher interest rates to contain inflation dampen consumer spending and the country’s growth, but the job market remains strong and the economy is moving forward.

China also faces its own problems. The policy of freezing all activity during Covid-19 outbreaks has crippled large swaths of the economy and increased supply chain disruptions across the world. In the last few weeks alone, dozens of cities and more than 300 million people have been under total or partial lockdowns. Extreme heat and drought further hampered power generation, forcing more factory closures.

The troubled housing market added to China’s economic instability. Hundreds of thousands of people are refusing to pay their mortgages because they have lost confidence that developers will deliver their homes. Trade also took a hit in August, and economic growth is expected to see its slowest pace in a decade this year — although it is likely to outpace US and European rates.

Countries that are able to supply vital materials and goods – mainly energy producers in the Middle East and North Africa – are doing well. India and Indonesia grow at unexpectedly fast paces as domestic demand increases and multinational companies look to diversify their supply chains. Vietnam is also benefiting from industries moving operations to its territory.

In any case, China, the US and the euro zone together account for about two-thirds of the world’s economic activity, and if all these powers slow down, it will be difficult for any country to remain immune to the consequences. Poorer people, who spend most of their income on food and energy, are hardest hit.

In Europe, anxiety over heating homes, shutting down production lines and energy bills rose this week after Gazprom, Russia’s state-owned energy company, said it would not resume natural gas distribution until for Europe to lift sanctions related to the invasion of Ukraine.

The European Commission is calling for a cap on wholesale gas prices and a review of electricity prices, which have reached record levels. In recent days Germany, Sweden, France and Britain have announced billion-dollar aid programs to ease pressure on households and businesses, along with rationing and conservation plans.

The cost of all these measures would be enormous, at a time when government debt levels are already staggering. Concerns about high debt led the IMF (International Monetary Fund) to issue this week a proposal to reform the EU structure for public spending and deficits.

Still, a merciless and inflexible reality remains: the scarcity of energy that countries can afford. At current prices, there simply isn’t enough to produce the steel, wood, microchips, plastic and other inputs used to make food, sanitary pads, bicycles, baby formula and more that consumers want.

Western central banks are expected to keep raising interest rates to make borrowing more expensive and force inflation down. This Thursday (8), the European Central Bank raised interest rates by 0.75 point, equaling their biggest increase in history. The Fed (Federal Reserve, US central bank) is expected to do the same this month.

The fear is that the vigorous drive to bring prices down will plunge economies into recession. Higher interest rates alone will not drive down the price of oil and gas — unless they cause economies to collapse so that demand is severely reduced. Many analysts are already predicting a recession in Germany, Italy and the rest of the eurozone before the end of the year. For poor and emerging countries, higher interest rates mean more debt and less money to spend on the most vulnerable.

“I think we’re living through the biggest development disaster in history, with more people being pushed faster into extreme poverty than ever before,” Goldin said. “It’s a particularly dangerous time for the world economy.”