Sanctions will hurt Russia far more than anything it can retaliate with

The West must show unity in dealing with Russia over Ukraine and find alternative sources of energy

A child pauses by the emblem of a Ukrainian military base as a pro-Russian soldier walks behind the main gate in Perevalne, Crimea. photograph: vadim ghirda/ap

A child pauses by the emblem of a Ukrainian military base as a pro-Russian soldier walks behind the main gate in Perevalne, Crimea. photograph: vadim ghirda/ap

Fri, Mar 21, 2014, 14:02

One of the few things that can be said with much certainty about the crisis in Ukraine is that the acronym BRICS is going to need a rethink.

Coined by a Goldman Sachs economist, the name represented a group of countries comprised of Brazil, Russia, India, China and South Africa. For a while, the BRICS were the core of all that was hopeful about the globalisation of the world economy: never before had so many people – hundreds of millions – been so quickly taken out of poverty.

The end of the Cold War seemed to be followed by a new era of economic co-operation and growth. The leaders of the BRIC countries (South Africa joined later) first met formally in 2009 and, amongst other things, called for a new global reserve currency.

This potshot at the dollar echoed earlier remarks made on several occasions by senior Russian politicians. In addition, grand plans have been laid down to create institutions to rival the IMF and World Bank. Much of the momentum behind all of this had already faltered – there has been a lot of turmoil and stress in emerging markets and economies that predates the annexation of Crimea. It is hard to see much headway being made now.

Russia is also part of the G8 grouping: it remains to be seen whether its membership of this club will survive current events. The rhetoric suggests an expulsion is likely but this can only be a very tentative conclusion. But if the threatened escalation of economic sanctions comes to pass, it is hard to see Russia either wanting or being allowed to remain a G8 member.

The West can sanction Russia in a number of economic ways. Regulators in the US are calling investors in Russian asset markets and are quietly warning about risks.

Denying access to capital markets is an obvious place to start. Not only do the Oligarchs need somewhere to stash their money but inward investment into Russia has been running at a reasonably significant clip. Capital flows into Russia can be expected to fall, at least for a while, without any official sanctions.

Old fashioned trade in goods and services is also significant and is dominated by the energy sector. The West might try to limit exports to Russia but this runs the obvious risk of retaliation.

Europe gets 30 per cent of its gas supplies from Russia through a variety of pipelines, five of which run through Ukraine. Many of the Baltic members of the euro area get 100 per cent of their gas from Russia.

Germany gets just over a third of its supplies from the same source, Italy 27 per cent. Even neutral Switzerland gets 12 per cent of its gas from the Russians. It is worth noting that there are a lot of long term contracts governing these transactions: Russia’s actions, the rule of law, or its absence, carry a resonance beyond the borders of the Crimea.

As Europe’s largest economy it is no surprise that Germany accounts for nearly a third of EU exports to Russia. In the context of Germany’s export machine it isn’t a significant number – around 3 per cent of the total – but is big enough to elicit worries from business associations and others representing the interests of the many thousands of small to middle-sized firms involved in this trade. (Irish exports to Russia are less than 1 per cent of all exports.) In addition, quite a lot of capital investment into Russia has had a German origin. There has already been an impact: KfW, a government-owned development bank, last week postponed a major deal that could have meant up to €200m being invested in Russia.

Poker face
Putin is looking like a better poker player than any of his Western counterparts. From a purely economic perspective, the potential consequences for Russia from sanctions are, over the long term, much greater than anything he can retaliate with.

He is betting that no US or European leader is capable of thinking strategically. The short term problem of trying to find replacements for Russian oil and gas is the only thing on Western minds and will dictate what they do next. He is willing to gamble that will not amount to very much. So far, the evidence is consistent with his wager.

In 1995, the then chancellor of Germany stated that European economic and monetary union was a matter of war and peace in the 21st century. Most people under 45 didn’t have a clue what Helmut Kohl was talking about. One possible consequence of political chaos on Europe’s border, events reminiscent of Germany’s antics in the late 1930s, is that Europe remembers what the EU is actually for.

The raison d’être of the union is the replacement of nationalist poison with the rule of law. That poison resulted, by my count, in 17 wars between Germany and France following Columbus’ discovery of the Americas.

These were not the only countries to go to war of course; Russia has been involved on multiple occasions. Since Columbus, only two European countries have maintained an unchanged, separate sovereign existence.

It is no wonder that against the background of war and political chaos, countless millions of Europe’s citizens upped sticks and availed of Columbus’ escape route. Charlemagne, Voltaire and Winston Churchill are just some of the prominent figures from history to have advocated a vision of a United States of Europe. The modern EU was first conceived in the ashes of 1945. Europeans need to reflect on all of this.

History clearly means a lot to Putin, much more than economics. That makes the situation potentially very dangerous. But the economics are reasonably clear: Russia needs the West much more than we need Russia. A strong poker player with a weak hand can be seen off as a bluffer. But that always needs nerve and resolve.

Arguably, Europe has actually shown plenty of both in dealing with its financial crisis. Critics (such as this columnist) argue that policymakers have been resolute in doing the wrong thing. The right thing to do now is to show unity and determination, find alternative sources of energy (and ways of compensating those most at threat from Gazprom) and play the long game: Putin is betting that we can do none of this.

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