Opinion – Martin Wolf: Putin’s War Requires Coordinated Global Economic Reaction

Vladimir Putin’s attack on Ukraine will remake our world. How this will happen remains unclear. Both the outcome of the war and, even more so, its wider ramifications, including those for the global economy, are generally unknown. But some points are already very evident. Coming just two years after the pandemic began, this is yet another economic shock, catastrophic for Ukraine, bad for Russia and significant for the rest of Europe and much of the world.

As usual, the impact of refugees is primarily local. Poland is already home to the second largest refugee population in the world, after Turkey. Refugees are also arriving in other Eastern European countries. More will come. Many will also want to stay close to their homeland, hoping to return soon. They need to be fed and housed.

However, the ramifications go far beyond Eastern Europe or even Europe as a whole, as an excellent interim economic outlook from the OECD (Organization for Economic Co-operation and Development) shows. Russia and Ukraine account for just 2% of global production and a similar share of world trade. The stocks of foreign direct investment in Russia and those of Russia elsewhere also account for only 1% to 1.5% of the global total. The broader role of these countries in global finance is also irrelevant. However, they are important to the world economy anyway, mainly because they are major suppliers of essential commodities, especially cereals, fertilizers, gas, oil and vital metals, whose prices on world markets have soared.

The OECD estimates that this shock will reduce world production this year by 1.1 percentage points below what it would have been. The impact in the United States will be only 0.9 percentage points, but in the euro zone it will be 1.4 points. The comparable impact on inflation will be plus 2.5 percentage points for the world, plus 2 points for the eurozone and plus 1.4 percentage points for the US.

Rising energy and food prices will reduce consumers’ real incomes much more than these losses in Gross Domestic Product. The real revenues of net energy and food importing countries will also be affected more than just their GDP. It is also likely that the OECD estimates are too optimistic. This will depend, among other things, on the duration of this vicious war and the possible spread of sanctions on China or embargoes on energy imports to Europe.

These expected direct impacts on production are much smaller than those of Covid: in 2020, world production ended up about 6 percentage points below trend. But a full recovery from Covid had not occurred before the arrival of this new shock, which has crippled international relations, heightened national security concerns and undermined the legitimacy of globalization. This tragedy will likely cast long shadows.

One reason for this is its impact on inflation and inflationary expectations. The Federal Reserve (US central bank) has become more aggressive. But he still believes in “immaculate disinflation”—the ability to contain inflation without much, if any, rise in unemployment. The European Central Bank is also facing a spike in inflation, which it will have to respond to. In practice, the tightening is likely to hurt activity and jobs more than expected, in part due to financial fragility.

More fundamentally, the emergence of geopolitical divisions between the West on the one hand and Russia and China on the other will jeopardize globalization. Autocracies will try to reduce their dependence on Western currencies and financial markets. Both they and the West will try to reduce their dependence on trade with adversaries. Supply chains will be shortened and regionalized. However, note that Europe’s dependence on parts of Ukraine was already regional.

Economic policy has only limited relevance in wartime. It cannot save those being attacked, although it may try to punish or deter those responsible. But it can and must respond to the consequences. Monetary policy must continue to be directed towards controlling inflation and inflationary expectations, as unpleasant as this may seem.

It is possible and necessary, however, for countries to apply their fiscal resources to caring for refugees and offsetting the impact of higher energy and food prices on the most vulnerable. The latter include many developing countries, especially net energy and food importers. They will require substantial short-term support. Special drawing rights created last year can now be used for these purposes. High-income countries do not need them and should donate or at least lend them to countries in greatest need.

The response to this tragedy will have to be much more than short-term. Just as Covid forces us to plan for how to deal with future pandemics, this war should force us to think more about security in a more hostile world than most of us anticipated or at least expected. Energy security will be reinforced by an even faster shift to renewable energy. This is no longer just something to do with the weather. In the short term, diversification of fossil fuel sources will also be essential.

Once again, it is clear that the West and especially Europe will have to make a large and coordinated increase in their collective defense capacity. This will cost dearly. Europeans have the resources to be more strategically independent. They must use them. As long as the isolationist right remains so powerful in the US, it will not only be right but wise.

Last but not least, Russia must remain an outcast as long as this vile regime survives. But we will also have to conceive a new relationship with China. We must continue to cooperate. However, we can no longer rely on this rising giant for essentials. We are in a new world. Economic decoupling is now certain to become deep and irreversible. I don’t see how to avoid this.

Translated by Luiz Roberto M. Gonçalves