The Economics of War circa 2022

By Dian Cohen
The Economics of War circa 2022

What a sad and disheartening time – war when war is unthinkable, Ukrainian lives torn apart, the world on tenterhooks about when and how it will end.

Russia is the eleventh largest global economy as measured by the value of its annual production of goods and services – behind Canada, Italy, France and India, among others. It is, however, a nuclear power, a dictatorship with dreams of former glory, led by a serial violator of national borders and so integrated into the global economy that stopping its invasion of Ukraine is complicated.

Military war is unseemly in the 21st century. Before the 20th century one could make an economic case for taking someone else’s land by violence – the winner could get richer and more powerful. No longer. Today, the most valuable economic assets are technical and institutional knowledge. These can’t be conquered by force. There has not been a “profitable” war fought since the middle of the 20th century – indeed, the cold war with the Soviet Union ended without any major military confrontation.

The Russian aggression is a neanderthal throwback. It does not seem to matter that this will be a high cost, low profit affair for the Russian people and their economy. OUR big problem is that non-military options will hurt us too. Without question this war will make it more difficult to manage global inflation, partly because energy and supply chains are deeply implicated.

Russia is a gigantic gas station — 41% of its exports are either crude or refined oil, natural gas or coal. The bulk of it goes to Europe and China. Leaving China out of it for a moment (they are still trying to decide whether being friends with the U.S or Russia will benefit themselves most), Russia needs Europe’s money as much as Europe needs Russia’s energy. So Russia and Europe are joined at the hip and a total economic blockade hurts both. Germany’s decision to pause the approval process for the Nord Stream 2 gas pipeline is definitely smart but not so much that Russia will call its troops home. The western countries will need to replace the Russian gas, and that becomes a problem for the western economies and the rest of the world. Germany has closed down all its nuclear plants, which don’t emit greenhouse gasses, and may turn back to dirty coal. Red flag for ameliorating climate change.

The Covid pandemic severely impacted the production of semi-conductor “chips” which are used in many household items like phones, computers, cars and kitchen appliances. There’s already a huge backlog. According to research firm Techcet, Ukraine supplies more than 90% of the U.S.’s semiconductor-grade neon, a gas used in the chip-making process. Russia supplies 35% of the U.S.’s palladium supply, a rare metal also used to make semiconductors. Another red flag if you’re waiting for your new car…

Now to financial sanctions – freezing the financial assets of prominent Russians, freezing Russian assets in banks outside of Russia, prohibiting the sale of Russian sovereign debt, banning Russian financial institutions from the international payments and messaging system called SWIFT.

The most important of these is the latter — cutting Russia off from SWIFT. In just 4 days, Russian interest rates have doubled, there is a run on their banks, the ruble has fallen drastically. The longer the war lasts the greater the devastation to the Russian economy. Amputation from SWIFT is drastic. A decade ago, Iran was amputated from SWIFT because of its nuclear program. At that time, its GDP was US$599 billion. In 2020 (the most recent stat), it was $US192 billion. Big pain goes both ways. BP has announced that selling its investment in Russian oil will cost it $25 billion. Some western banks invested in Russia may be in danger of default.

Let us hope that ordinary Russians, who will feel the brunt of the pain, will again say “nyet” to their political leaders. Let us also hope our political leaders have the skill sets required to settle conflicts both at home and abroad.

Dian Cohen, C.M., O.M., economist

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