Opinion – Martin Wolf: War in Ukraine tests Europe’s moral fiber and economy

How should the EU (European Union) manage the economic costs of Vladimir Putin’s war? It is not the same thing as minimizing these costs. This is a war on which the future of Europe, perhaps of democracy itself, will depend.

In these times, the objective of economic policies is to sustain the war effort. Policies should try to maximize the costs to the aggressor relative to those of the EU, especially those of its most vulnerable citizens. How should this be done?

To think about this question, we need an analytical framework. Olivier Blanchard, former IMF chief economist, and Jean Pisani-Ferry present this in recent work.

They list three challenges: first, “What is the best way to use sanctions to deter Russia, while limiting adverse effects on the EU economy?”; second, how to deal with cuts in real incomes resulting from the increase in the cost of energy imports?; and third, how to manage the increase in inflation caused by higher food and energy prices, which is on top of the increase in post-Covid inflation?

It goes without saying that any of these analyzes are provisional. In wartime, the future is even more uncertain than usual.

On the impact of sanctions on Russia, consider a recent comment from Rystad Energy: “Despite the severe oil production cuts expected in Russia this year, fiscal revenue will increase significantly to over $180 billion. billion) due to rising oil prices… This is 45% and 181% more than in 2021 and 2020 respectively.”

This is not to deny the damage done by the sanctions: the IMF predicts that the Russian economy will shrink by 8.5% this year. But it does mean that higher prices are more than offsetting volume reductions. Consumers are suffering, but they are also funding the invasion of Ukraine. That’s bad policy.

The aim should at least be to decrease the revenue Russia earns from its exports, not increase it. Several economists have considered what this might require. Seven points emerge from their analyses.

First, the EU’s vulnerability to Russia, but also its power over it, is greater in gas than in oil, because gas is more dependent on fixed infrastructure. This makes it more difficult for Russia to diversify sales (though also EU purchases).

Second, the most effective way to reduce revenue for Russia is not an embargo but a punitive tax or tariff, which should transfer Putin’s “energy lease” to consumers.

Third, imposing tariffs would produce revenue that can be used to help those who suffer losses in their real income at this time.

Fourth, a tax imposed by the EU only on Russian exports would achieve more on gas than on oil, because of the greater difficulty in diversifying gas exports.

Fifth, trade sanctions would be more effective the greater the number of participating countries.

Sixth, we could expand oil sanctions by imposing shipping sanctions. Finally, the costs of these measures to Russia would be a large multiple of their costs to the EU and its allies.

Reaching consensus on effective measures is difficult but crucial. A way has to be found to transfer more revenue from Russian exports to consuming countries.

But no matter what is done in this regard, there will be significant costs of the war for rich importing countries: higher defense spending; higher spending on energy infrastructure; assistance to refugees; and, finally, substantial support to hard-hit developing countries.

Inevitably, the political question that stands out will be how to cushion the blow to domestic consumers. Should this be done through energy subsidies, payment transfers or price controls? A large part of the answer depends on which sanctions regime is adopted.

But the general point is that subsidies will tend to balance sanctions by increasing consumption rather than reducing it. It would be better to increase purchasing power transfers to vulnerable households, leaving them to decide how to spend it.

Oil price controls were a disaster in the 1970s. I don’t see a good reason why they would be better today. If we want to limit windfall profits, it would be better to tax them.

Blanchard and Pisani-Ferry also ask how transfers or other spending measures would be financed. Since war is a short-term emergency, there is a strong thesis in favor of additional borrowing from governments. Furthermore, given current long-term interest rates (still very low) and prospective increases in nominal Gross Domestic Product (bolstered by inflation), extra debt would be affordable.

This then raises the question of monetary policy. The impact of the war will reinforce upward price pressures, risking an inflationary spiral of wages and prices, while weakening demand as real incomes are crushed.

Blanchard and Pisani-Ferry suggest that these two effects neutralize each other. In that case, they argue, monetary policy should continue on the hardening path traced before the Russian invasion.

But they also suggest that fiscal measures could be geared towards lowering price inflation, thereby reducing the risks of a wage and price spiral. They further suggest that such fiscal measures could be inserted directly into the salary discussion process. I’m skeptical. But it could work in northern Europe.

The conclusion I draw from these analyzes is that the war is a major economic shock, but it is much more a political and moral shock. A brutal conflict has reached Europe of a kind not seen since the Second World War, and even where some of its worst atrocities took place.

For Germany in particular, it is a time of challenge and opportunity. The challenge is to defend European liberal civilization. The opportunity is for historic redemption. Russia cannot prevail. That’s the most important. There will really be suffering. But it must be supported by a greater cause.

Translated by Luiz Roberto M. Gonçalves