The Great Economic War (GEW) (Part 1: The beginning)

The Great Economic War (GEW) (Part 1: The beginning)

Phuah Eng Chye (30 July 2022)

Russia’s invasion of Ukraine has two fronts – the military and the economic. On the military front, it is a test of modern weaponry and integrated warfare between reasonably-matched opponents. While opinions fluctuate, scenarios[1] have settled on Russia establishing control over Donetsk, Luhansk and possibly the coastal ports.

Benjamin Jensen thinks “the war will likely enter a new phase, more like the frozen conflicts Russia has used to destabilize its neighbors since the fall of the Soviet Union than current large-scale combat operations…Russian ground forces are no longer as fearsome as they once appeared, but Moscow’s ability to shoot large volumes of cruise and ballistic missiles remains a challenge in Ukraine”. “Russia’s greatest sources of leverage over Ukraine and Europe remain its central position in global resource markets as well as its strategic reach and nuclear stockpile…Looking more broadly, economic sanctions still have not truly attacked Russia’s central role in global resource markets or the financial institutions Putin uses to sustain its war in Ukraine”. He argues “the West needs to start preparing now for that phase and reducing Russia’s advantages in future competition”. “When the anticipated cease-fire arrives, it will give a window of opportunity to start reducing Russian coercive advantages…The United States will need to work with its partners in Europe to increase infrastructure investments associated with the European Deterrence Initiative to expand strategic resource reserves and dual-use infrastructure that not only sustains military forces but reduces European dependence on Russian energy”. U.S. defense expenditures will need to shift to offset Russian strike capabilities that have proven effective in Ukraine. This includes sensor networks and working with partners and allies on integrated air and missile defense. Partners shouldn’t feel their cities are held hostage”.

Tatiana Stanovaya’s view is Russia’s goal is not to seize control of large parts of Ukraine but to “stop the West from using Ukrainian territory as a bridgehead for anti-Russian geopolitical activities…To follow through on these goals, Russia needs to sustain its military presence on Ukrainian territory and keep attacking Ukrainian infrastructure…happy to wait until Ukraine concedes that Russia is here forever”. Given “Ukraine is seen as an anti-Russian weapon in Western hands – and destroying it will not automatically lead to Russia’s victory in this anti-Western geopolitical game…a deal between Russia and Ukraine is only possible as an extension of an agreement between Russia and the West or as a result of the collapse of Putin’s regime. And that gives you an idea of how long the war could last: years, at best”.

Though the economic war on Russia was justified on grounds of the Ukraine invasion, yet the sanctions did not deter Russia or nor persuade it to negotiate. If anything, the economic war is unlikely to be over even if Russia and Ukraine reach an agreement for a military ceasefire because the sanctions are intended to permanently cripple the Russian economy and military; and, if possible, to achieve regime change.

Jane Vaynman and Tristan A. Volpe explain “there have been calls on President Vladimir Putin to end hostilities and military operations in Ukraine…If the United States and Europe hope to compel Putin to stop the war, they will need to tell Putin what specific actions he can take to reconnect Russia to the global economy. A compellence strategy imposes costs with the threat of more pain to come until an adversary changes its behavior in some way. It must involve clear demands. Otherwise, the adversary could assume that no amount of concessions will be sufficient to end the punishment”.

Jane Vaynman and Tristan A. Volpe note “sanctions will be strongest in their initial use, before Russia has a chance to insulate its economy even further. So, states applying economic pressure are best served using these tools now, rather than assuming that they would have similar effects if threatened or reapplied in the future. The effects of economic levers are also likely to grow as the sanctions remain in place. This creates an additional incentive for Western states to keep the sanctions in place: It allows them to potentially avoid imposing additional measures that they themselves will find more costly…It’s also not likely that any of the sanctioning countries will be able to bail out from the sanctions regime easily. The highly publicized nature of this coordination also signals the strength of the opposition to Russia – countries are less likely to bow out of terms when they commit themselves collectively in front of public audiences. Finally, the coordination of sanctions took considerable effort, so stakeholders are likely to become vested in maintaining this economic punishment regime until a potentially large set of goals, including retributive punishment against Russia, is met”.

In this context, “some economic sanctions on Russia can be lifted with a policy statement, but that means they can be reinstated or changed as well, and that might give Russian leaders pause. From a practical standpoint, it would be fairly easy for states to alter the content or timing of a sanctions policy change. There is no way to assure Russia that a particular policy will indeed be announced as soon as its tanks cross back into Russia. In a de-escalation scenario, if Russia withdraws from Ukraine, these steps will be difficult to reverse quickly. They would be giving up tactical positions, and pulling back lines of logistical support. What if Russia takes these steps but the West decides to renege and not announce any change to the sanctions policy? Or lift some sanctions but not others? At that point, Russia would have even less leverage to influence the policy choices. Western governments also cannot promise a return to business as usual because they cannot control the willingness of private companies to do business with Russia”.

Jane Vaynman and Tristan A. Volpe note “compellence usually benefits from laying out specific demands with deadlines by which time the adversary must comply…Without a deadline, the adversary could use diplomacy as a ruse to buy time while advancing its objectives. But in this case, Western countries may well be deliberately delaying their demands, even though it seems to violate a core tenet of compellence…Delayed demands may be quite beneficial in the context of the Ukraine conflict for three reasons. First, withholding demands could buy time for economic sanctions and military aid to inflict visible costs on Russia…states have also let the punishment kick in before laying out specific criteria for it to end… As key actors in Russia feel the mounting costs of the conflict with each passing day, they could become more pliable to Western demands to change this status quo. Second, the situation on the ground in Ukraine may be moving too fast for the West to nail down concrete demands. By exercising patience, Western states put themselves in a better position to identify more specific bargaining terms as the situation solidifies…The grim logic of war termination therefore means that leaders may be wise to hold off on issuing public demands during the initial stages of battle. Third, the absence of public demands opens space for Western diplomats to probe conditions behind closed doors…through backchannels or intermediaries. This move could help the West to manage the dilemma between imposing significant punishment on Putin while eventually presenting him with an off-ramp to end the war. Private demands would give the United States and its allies more room to maneuver without the appearance of backing down or relieving pressure”.

In relation to this, “the lack of clear demands might fuel a belief that Putin already seems to hold – the notion that the West is determined to undermine and weaken Russia…In this environment, Putin himself, his top leadership, and the broader Russian public may become increasingly unlikely to believe any Western off-ramp offers made down the road. The lack of public demands also erodes the credibility of any promises attached to private discussions. It is easier for leaders to disavow pledges made away from public scrutiny. Russia may anticipate this and see private assurances as inherently not credible, or worry that Western leaders will be pressured by their own publics to reverse assurances when they are revealed”.

Jane Vaynman and Tristan A. Volpe note “the multilateral approach also creates incentives for this coalition to continue its pressure even in the event of Russian de-escalation over Ukraine. Deep differences could emerge among sanctioning states as to what concession or change of behavior by Russia would be sufficient to lift sanctions. For example, some sanctioning states will themselves face greater blowback costs from sanctions, and so may be willing to accept less from Russia in order to end sanctions sooner. Others – including, of course, Ukraine itself – could set the bar higher. This dynamic makes it hard to use promises to lift sanctions as a credible bargaining tool. It also privileges maintaining the restrictions that states already managed to agree upon”.

Jane Vaynman and Tristan A. Volpe conclude “the relative power of the Western bloc may increase further as the Russian economy collapses. Russia’s weakness may be perceived as an opportunity to use sanctions to further degrade its ability to fight future conflicts…Knowing that an even more powerful West will be tempted to continue pressing, Russia has few reasons to believe an off-ramp that includes claims that sanctions would be lifted. This expectation would strangle any prospects for diplomacy…The difficulty of making both threats and assurances credible haunts compellence strategies in general”.

Liana Fix and Michael Kimmage thinks “time could be on Russia’s side. A protracted war, lasting from months to years, might be an acceptable and perhaps even favorable outcome for Moscow. It would certainly be a terrible outcome for Ukraine, which would be devastated as a country, and for the West, which would face years of instability in Europe and the constant threat of a spillover. A long-term war would also be felt globally, likely causing waves of famines and economic uncertainty. A forever war in Ukraine also runs the risk of eroding support for Kyiv in Western societies, which are not well positioned to endure grinding military conflicts, even ones occurring elsewhere. Postmodern, commercially oriented Western societies accustomed to the amenities of a globalized peacetime world could lose interest in the war – unlike Russia’s population, which Russian President Vladimir Putin’s propaganda machine has agitated and mobilized into a wartime society”.

Liana Fix and Michael Kimmage explain “Putin has already paid a steep price for his invasion. From his perspective, any future peace agreement[2] that doesn’t win major concessions from Ukraine would be out of proportion with the loss of life, loss of material, and international isolation Russia has experienced. Having mobilized Russians for war, Putin may not settle for an inglorious peace. Although the war has been a strategic mistake for Russia, Putin would probably damage himself politically by admitting to his blunder…devastate the Russian economy over time…Russia has instead solidified NATO and strengthened transatlantic ties. That will make it harder – not easier – for Putin to cut his losses in Ukraine”.

Liana Fix and Michael Kimmage adds “Putin may resort to a war of attrition, which holds several advantages for him. If he is to be defeated, he can defer defeat with a long war, and perhaps even hand the doomed conflict off to a successor. A long war also plays to some of Russia’s innate strengths. It would allow Russia the time to conscript and train hundreds of thousands of new soldiers, which could shift the outcome. Should the war last for years, the Russian military could rebuild its depleted forces, especially if Russia’s state budget remains stable…Nor does Russia necessarily need battlefield wins to exert pressure on Kyiv, particularly if the war is drawn out…Ukraine’s economic ruin is one of the war’s important, if less visible, outcomes. A war of attrition might help Putin exert pressure on the transatlantic alliance, especially if support for Ukraine starts to wane in the West. Putin sees Western democracies as unstable and inefficient, and may be betting on political transitions in Europe or the United States as the strain of the war grows over time…Convinced that their hold on power is eternal, dictators can often afford to play the long game. Or at least they think they can”.

Emma Ashford and Joshua Shifrinson point out under the stability-instability paradox, “states, stalemated in the nuclear realm, might be more willing to escalate in conventional terms. There are multiple paths through which such an escalation to a broader war might happen today. One scenario stems from the economic war the West has launched against Russia…It is hard to think of historical parallels to this sudden isolation of a major economy, and the few comparable historical cases – Italy in the 1930s, Japan in the 1940s – do not bode well. Indeed, if the economic damage in Russia becomes severe enough, Putin may decide that it is worth retaliating through non-military means such as cyberattacks. He may decide things are bad enough that it is worth forgoing energy revenues and shut down some gas pipelines to Europe, which would send energy prices soaring. Russia would presumably hope to use these steps to gain leverage over Western policy, but they could easily backfire: cyberattacks could trigger consultations under Article 5 of NATO’s founding treaty, which states that an attack against one member state will be considered an attack against them all. This could result in retaliatory cyberattacks on Russia and continue from there. One might hope policymakers find off-ramps at that stage, but there are no guarantees”.

Liana Fix and Michael Kimmage notes “Ukraine also has many reasons not to end the war through a premature cease-fire on Russian terms”. Its military has performed well while it could not agree to Russian demands for territorial concessions and to demilitarise. “Having pocketed these concessions, Russia could later restart the war against a demilitarized Ukrainian army to finish what it started”. In addition, concessions are likely to be opposed by the Ukrainian population. “A long-term war nonetheless poses political challenges for Ukraine. If the war drags on for years, Ukraine will have to keep its political system intact and its democracy alive…A drawn-out war in Ukraine would have profound consequences for the European continent…It would contain within itself a war zone charged with the threat of escalation…The exodus of Ukrainian refugees will continue, and with time migrants may decide to settle in Europe permanently”.

Nicholas Mulder points out “the macroeconomic and macrofinancial consequences of global sanctions are insufficiently understood…examine sanctions use in the 1930s, when democracies similarly attempted to use them to stop the aggression of large-sized autocratic economies such as Fascist Italy, imperial Japan, and Nazi Germany. The crucial backdrop to these efforts was the Great Depression, which had weakened economies and inflamed nationalism around the world. When Italian dictator Benito Mussolini invaded Ethiopia in October 1935, the League of Nations implemented an international sanctions regime enforced by 52 countries. It was an impressive united response, similar to that on display in reaction to Russia’s invasion of Ukraine. But the league sanctions came with real tradeoffs. Economic containment of Fascist Italy limited democracies’ ability to use sanctions against an aggressor who was more threatening still: Adolf Hitler. As a major engine of export demand for smaller European economies, Germany was too large an economy to be isolated without severe commercial loss to the whole of Europe. Amid the fragile recovery from the Depression, simultaneously placing sanctions on both Italy and Germany – then the fourth- and seventh-largest economies in the world – was too costly for most democracies. Hitler exploited this fear of overstretch…by moving German troops into the demilitarized Rhineland in March 1936…German officials were aware of their commercial power, which they used to maneuver central European and Balkan economies into their political orbit. The result was the creation of a continental, river-based bloc of vassal economies whose trade with Germany was harder for Western states to block with sanctions or a naval blockade. The sanctions dilemmas of the 1930s show that aggressors should be confronted when they disrupt the international order. But it equally drives home the fact that the viability of sanctions, and the chances of their success, are always dependent on the global economic situation. In unstable commercial and financial conditions, it will be necessary to prioritize among competing objectives and prepare thoroughly for unintended effects of all kinds. Using sanctions against very large economies will simply not be possible without compensatory policies that support the sanctioners’ economies and the rest of the world”.

Nicholas Mulder notes “Western policymakers thus face a serious decision…if the West decides to step up the economic pressure on Russia further still, far-reaching economic interventions will become an absolute necessity. More intensive sanctions will inflict further damage, not just to the sanctioners themselves but to the world economy at large…An intensification of sanctions will cause a cascade of material shocks that will demand far-reaching stabilization efforts. And even with such rescue measures, the economic damage may well be serious, and the risks of strategic escalation will remain high. For all these reasons, it remains vital to pursue diplomatic and economic paths that can end the conflict. Whatever the results of the war, the economic offensive against Russia has already exposed one important new reality: the era of costless, risk-free, and predictable sanctions is well and truly over”.

There doesn’t appear to be much room for either side to provide concessions on the military or economic fronts. On this note, it is probably be easier to de-escalate the military conflict than the economic war. A full-scale war is too costly and destructive and it is reasonable to expect a negotiated ceasefire in the medium term. On the other hand, the economic war is likely to escalate and broaden with more countries affected or getting involved. Gilbert Doctorow notes at a recent conference, Russian panellists thought “it is time for Russia to respond directly and strongly to the full economic and hybrid war that the United States and Europe are now waging…They call for an immediate cut-off of gas supplies to Europe, to an embargo on export of titanium and other essential raw materials for advanced industrial production in the West.  One alternative to these cruel and devastating moves against Europe would be to try it all out first on Japan…impose a total commercial embargo on Japan, beginning with hydrocarbons and extending into all spheres, such as fishing concessions. Moreover, Russia should position tactical nuclear weapons and other significant armaments on the Kurile Islands as a firm reminder of who owns these territories now and forever…panellists was also in favor of all-out war on Ukraine, to hell with collateral civilian casualties. The war must be ended quickly, decisively and with minimum further Russian casualties…Then there was also the question of war mobilization…the Russian economy has to be put on a full war footing, with decision making concentrated in the Executive and removed from the hands of entrepreneurs. This is required not for the ongoing conflict with Ukraine but for continuation of the wider war with the US-led West that constitutes the context for the conflict”. 

Stephen M. Walt points out “sooner or later, the fighting in Ukraine will stop. No one knows how or when or what the final resolution will be…it is a world where hard power still matters, as everyone has now been reminded”. He thinks the war in Ukraine should not be construed as a battle between the liberal world order and the forces of autocracy. “The war in Ukraine is a significant event…because it signals the end of the brief unipolar moment (1993-2020) when the United States was the world’s sole genuine superpower and because it heralds a return to patterns of world politics that were temporarily suppressed during the short era of unchallenged U.S. primacy. The end of that era was in sight long before Russia invaded Ukraine, however…for the first time since the early 1990s – but hardly the first time in history – there are rival great powers on the opposite sides of a major war. But this is a reversion to familiar patterns of great-power conflicts (and proxy wars) and not something novel or unique…this war is more accurately seen as marking the official end of the brief quasi-peace that followed the end of the Cold War”.

Opening salvos and long-term views

The speed, breadth and ferocity of the Western attack on the Russian economy blindsided many. Nicholas Mulder relates “in the space of less than three weeks, the United States and its allies have cut major Russian banks off from the global financial system; blocked the export of high-tech components in unison with Asian allies; seized the overseas assets of hundreds of wealthy oligarchs; revoked trade treaties with Moscow; banned Russian airlines from North Atlantic airspace: restricted Russian oil sales to the United States and United Kingdom; blocked all foreign investment in the Russian economy from their jurisdiction; and frozen $403 billion out of the $630 billion in foreign assets of the Central Bank of Russia. The overall effect has been unprecedented, and a few weeks ago would have seemed unimaginable even to most experts: in all but its most vital products, the world’s eleventh-largest economy has now been decoupled from twenty-first-century globalization”. “Virtually overnight, Russia’s impending isolation has set in motion a massive corporate flight[3]. In what amounts to a vast private sector boycott, hundreds of major Western firms in the technology, oil and gas, aerospace, car, manufacturing, consumer goods, food and beverage, accounting and financial, and transport industries are pulling out of the country. It is noteworthy that these departures are in many cases not required by sanctions. Instead, they are driven by moral condemnation, reputational concerns, and outright panic. As a result, the business retreat is deepening the economic shock to Russia”. “The immediate shock to the Russian economy is the most obvious. Economists expect Russian GDP to contract by at least 9-15 percent this year, but the damage could well become much more severe. The ruble has fallen more than a third since the beginning of January. An exodus of skilled Russian professionals is underway, while the capacity to import consumer goods and valuable technology has fallen drastically”.

Initial predictions were dire; predicting Russia’s economy, with a population of 144 million and GDP of $1.4 trillion, as shrinking by a third; its banking system as threatened by high interest rates, capital controls, bankruptcies and bank runs; key industries crippled by deprivation of critical technologies[4], parts, foreign expertise, investments and finance; civilians suffering from a loss of purchasing power, unemployment, and shortages of food, medicine, and consumer goods. It is thought the economic war against Russia would keep its economy in a state of autarky[5].

While the GEW was a surprise, nonetheless both sides made their moves swiftly; reflecting preparations[6]. The economic attack was blunted by Russia’s disciplined response. Gian Maria Milesi-Ferretti notes “Russia is a net creditor on international markets” with total foreign assets of $1.62 trillion versus $1.18 trillion in foreign liabilities as at September 2021; a current account surplus of $120 billion (over 7 percent of GDP) and foreign exchange reserves exceeding $630 billion (1.7 times imports) in January 2022. While the asset seizure meant its OECD reserves were superfluous, it indicates the depth of Russia’s economic defences.

The shocks were immediate in the currency, debt and commodity markets. Russia responded by imposing capital controls, shutting the stock market and raising interest rates to 20% – proven defences against speculative currency attacks. Russia also implemented counter-measures[7] such as the special economic measures[8] on individuals and companies from “unfriendly” countries covering divestment of Russian assets, Russian debt payments to foreign creditors, trade restrictions halting critical exports; and left open the possibility of nationalising foreign assets of companies exiting Russia. Russia seized commercial jets under lease, required unfriendly countries importing oil and gas to pay in roubles and closed its airspace. Enrico Bonadio and Alina Trapova notes “in early March, the Russian government issued a decree saying that Russian companies are no longer obliged to compensate owners of patents, utility models and industrial designs from unfriendly countries”. The rouble and interest rates have recovered to around pre-war levels.

On the economic front[9], Ekaterina Arapova notes Russia introduced “a stimulus package of reforms totalling more than 1 trillion rubles, the supporting structures of which are (1) support for small and medium-sized businesses, (2) backbone industries and enterprises (primarily information technology, agriculture, manufacturing, the food industry, trade, construction, tourism, medicine, etc.), as well as (3) strengthening social guarantees and tax breaks for ordinary people. The main instruments of state support are concessional business lending programs, subsidising interest rates, providing credit and tax holidays, simplifying administrative procedures, and so on. At the same time, the authorities are tightening the rules for foreign exchange transactions for companies and citizens, as well as imposing restrictions on investments from foreigners…to mitigate the acute phase of the crisis should be to reduce and defer tax payments and the payment of insurance premiums for pensions, social and medical insurance…The introduction of a moratorium on bankruptcies among enterprises…actions already taken by the Central Bank to support commercial banks – expanding limits on providing liquidity, eliminating penalties for violations of foreign exchange positions, support in terms of assessing the creditworthiness of troubled banks and accounting for foreign exchange assets – can partially support banks, while the moratorium on bankruptcies has wider scope and supports the real sector…accompanied by an easing of monetary policy”.

There are few signs[10] the downturn will reach crisis proportions in Russia. Views on the long-term impact of the GEW on Russia vary considerably.

  • Ghost’s view is the “systemic crisis for the political economy of energy exports and rents key to the regime’s notional stability”. He argues the energy sector has a pivotal role in the Russian economy and that knock-on effects from even marginal declines in oil production, coal exports and production, or natural gas exports can undercut aggregate demand, investment and fiscal revenues, private sector consumption and state procurements. He thinks “it’s safe to assume a significant decline in oil exports” and production due to Gazprom’s refusal to supply via spot trades in Europe and the demand to be paid in rubles and its inability to redirect export capacity to China and other markets.
  • Edoardo Saravalle notes “it is the reaction functions of firms to such statements that gives sanctions their power…The United States sanctions a Russian firm, a US equity index provider removes it from its index, an asset manager who must mimic the index tries to sell the stock, fails, and the entire market short-circuits. During the imposition phase, the biggest ally of a US sanctions regime is overcompliance. The memory of heavy US fines for sanctions evasion and the fear of losing access to the dollar system ensure that companies go well beyond the letter of the law when responding to US measures. Despite the energy carve-out, skittish traders have stayed away from Russian oil, waiting to see whether the United States will convince Europe to ban imports. The effects of such overcompliance build on each other. In doubt, better to stop dealing with Russia altogether”. The Russian airline industry is an example. “First, there was disconnection from a key network. Aeroflot, the country’s flagship airline, lost access to back-end flight booking software Sabre, the sort of SWIFT-like invisible-yet-all-important infrastructure that amplifies the effects of sanctions. Next came the commercial squeeze. EU sanctions forced European leasing companies to void contracts with Russian airlines, entitling them, at least in theory, to repossess more than half of Russian aircraft. Fearing the repossession, the Russian government stopped the airlines from flying abroad. Then, a new form of pressure came in the form of export controls. In a new development, the US and EU economic campaigns focused not just on financial measures but on the supply chain as well, limiting the supply of specific physical parts and components to Russian airlines. With limited access to parts, the Russian fleet will slowly degrade as it cannibalizes itself for spare components. On the voluntary front, Manchester United severed its sponsorship deal with Aeroflot”.
  • Maria Shagina and Emily Kilcrease note while Western nations already heavily restrict the export of military or dual-use technology to Russia, “the United States and more than 30 other countries introduced sweeping export controls on strategic technology items to Russia, including semiconductors, information-security and telecommunications systems, electronics, and computers” to degrade its military power, technological base and industrial capacity. Russia is “highly reliant on foreign technology…in 2020 Russia imported around $400 million worth of semiconductor devices and roughly $1.25 billion worth of electronic integrated circuits”. “Without advanced and imported chips, Russia can’t restock precision munitions” such as its Iskander-M, the Kalibr, the Kh-101 and 9M727 cruise missiles. “Russia’s aerospace and automotive industries have been hit the hardest. The finalization of the country’s flagship airline project, the long-haul civilian aircraft MC-21, will be delayed. National carmaker Avtovaz has faced an ongoing crisis in the supply of electronic components. The Moscow subway’s Troika cards may no longer be operational, as restrictions have halted the delivery of chips from the Dutch company NXP. Even Uralvagonzavod, Russia’s armored vehicle manufacturer, has halted tank production, as it has run out of foreign parts”. The Russian manufacturers of domestic processors, Baikal Electronics and the Moscow Center for SPARC Technologies (MCST) which rely heavily on Western architecture, imported components, and foreign manufacturers “have been placed on the U.S. Department of Commerce’s Entity List, barring them from receiving any U.S. technology”. “The country’s leading chipmaker…Mikron Group sells products such as power management chips, radio frequency identification chips, and bank card microcontrollers. Since the global pandemic, Mikron has been experiencing difficulties with the supply of materials”. Russia has responded by expanding “support measures for the industry by reducing taxes, increasing financing, and providing larger subsidies. The updated plan seeks to reverse-engineer foreign technology and transfer production to Russia and China, as well as make every component that it currently imports by 2024. The government also plans to increase the number of Russian design centers from 70 to 300 by 2030 and allocate 2.7 trillion roubles to develop the electronics industry. Mimicking Soviet-style planning, the new strategy suggests a rigid demand-and-supply mechanism for determining the price of electronic items…the Russian government included both Baikal Electronics and MCST on its list of systemically important companies…allows them to apply for preferential subsidies and guarantees from the state budget”. They think Russia’s approach “fails to offer a comprehensive solution, encompassing the development of materials, equipment, building factories, and creating final products…the new wave of domestic repression following the war in Ukraine has accelerated the brain drain, and will only aggravate the situation further. In March, the government reported that 50,000 to 70,000 IT specialists left the country. Russian officials announced that the Russian economy will need about 1 million specialists”. Russia has increasing pivoted to Asia for supplies. In 2018, China, Taiwan, and Malaysia became crucial suppliers of electronic components – such as integrated circuits, diodes, transistors, resistors, and capacitors – previously procured from NATO states (Germany, Italy, and France). In 2021, nearly a third of Russia’s imported chips came from China while Malaysia, Taiwan, and Vietnam accounted for 14%, 12.6%, and 11% respectively. “Within weeks of imposing the new export controls, the United States issued warnings to Beijing not to backfill technology in violation of the export controls, and to date, there has not been evidence of attempts to do so. But as the war of attrition continues, there are concerns that China may supply semiconductors and other high-tech components to Russia to mitigate the blow”.
  • Stephen M. Walt thinks that “even if Russia achieves some limited gains in the Donbass, the war will accelerate its relative decline…the long-term consequences of that achievement will leave Russia worse off as a whole. Unless he erects a new Iron Curtain, talented young Russians will continue to leave. State revenues will decline as more and more countries wean themselves off Russian oil, gas, and coal…Russia’s autocracy may be more secure but less consequential. The world of the future will be closer to true bipolarity than lopsided multipolarity, with Russia playing the role of China’s junior partner (and one whose economic vitality and long-term strategic value may be diminishing). It won’t help Beijing’s image to be closely linked to Russia’s destruction of Ukraine, and Moscow could need more propping up as Russia’s economy falters and its population ages and shrinks”.
  • Dimitri A. Simes notes Russian businessmen and academics consider the sanctions “a blessing in disguise”. While creating significant complications, in the long-term they will provide Russia with the needed stimulus to revive its domestic industries. “Despite the Kremlin’s import-substitution push, many sectors of the Russian economy still remained heavily dependent on the West”. A study by the Russian Higher School of “found that the U.S., Canada, and E.U. accounted for half of Russia’s foreign value added, including components for machinery, medications, and cars”. Oleg Buklemishev “explained that notwithstanding the growing political tensions over the years, most of Russia’s trade outflows, ports, railroads, and financial infrastructure were oriented around the West. Consequently, many Russian business people opted to continue doing business as usual even as the Kremlin urged them to localize production or pivot to Asia”. Sergey Karaganov points out “what happened with the oligarchs showed everybody that you should not do business with the West under any circumstances”. Elvira Nabiullina warned the restrictions “would make it substantially more difficult for Russian consumers and manufacturers to acquire a wide range of finished goods and components”. She predicted that Russia would begin to meaningfully feel the sting of sanctions in the second and third quarters of this year, as existing stockpiles begin to run down. Economic recovery, she said, would largely depend on how quickly Russian businesses will be able to establish new production and supply chains”. Nonetheless, Nikolai Dunaev notes Russian businessmen have “found some ways to adapt. Some have found alternative suppliers in China, India, Turkey, and the Middle Eastern countries, while others have had to temporarily lower production or change the assortment of goods they produced. However, the important thing is that everyone is finding solutions to their problems, one way or another”. Some entrepreneurs reported sanctions have boosted their businesses. Valentina Andreeva notes her premium furniture business was boosted by a “wave of patriotism” among wealthy Russians that flocked to domestic brands. Butrimov points out it is more “difficult for airplane manufacturers to find replacements for certain Western imports, especially high-tech components such as advanced engines and electronics. However…Russia will be able to develop its own alternatives over the next five years… one of Russia’s biggest advantages is that it possessed its own well-developed aviation industry just a few decades ago… Although much of that capacity was degraded in the decades following the collapse of the Soviet Union…Russia still retained a large cohort of well-trained engineers and the ability to produce workable models…We are seeing the emergence of new small companies that produce key components and the government is trying to promote the manufacturing of Russian equipment…kicked off the process of import-substitution, the result of which Russia will no longer be dependent on everyone”. Sergei Abramov notes his Institute of Program Systems at the Russian Academy of Sciences “could no longer pay for services such as IP addresses, telecommunication infrastructure, servers, and even apps like Zoom or Dropbox…danger of Russia falling technologically behind…developing cutting-edge technologies in the Internet age is only possible through international cooperation since innovation requires large financial, technological, and knowledge resources…Perhaps even more worrisome, the difficulty of working under sanctions could push many talented Russian IT specialists to seek better opportunities elsewhere”. “The Russian Association for Electronic Communications caused a sensation when in March it reported that 50,000 to 70,000 specialists had fled the country and that another 100,000 were expected to leave the following month. By contrast, a study published in late May by the Russoft software developer’s association estimated that only 40,000 IT workers had moved abroad so far this year. Perhaps even more significantly, the Russoft study concluded that up to half of those specialists could return to Russia before the end of the year. Valentin Makarov…why he expects so many Russian IT workers to return home. First, the influx of well-paid Russian professionals to neighboring countries has caused real estate prices in those places to sharply increase, making long-term relocation far more costly. Second, many Russians who moved abroad reported experiencing hostility from locals. Finally, Makarov believes that the Russian government’s new package of incentives for IT companies and workers, which includes exemptions from taxation and military service, could help entice many back to Russia…although adapting to the new post-sanctions reality would undoubtedly be difficult…some Russian companies had seen their sales increase by 2-8 times in recent months, fueled by a growth in demand for domestic IT solutions following the exodus of Western tech giants…The next step…is to look for opportunities to expand into the markets of developing countries, which he says accounts for 40 percent of the total global IT market share…In just three months, Russia’s relationship with the outside world has been completely upended. The post-Soviet era of globalization, in which Russia sold natural resources to the West in exchange for key components, technologies, and finished goods, is likely gone for good. But what comes next is far from certain”.

Large global economic spillovers

The global economic spillovers from GEW are substantial. A World Bank report[11] “identified five direct trade and investment channels through which countries will be affected by the war in Ukraine. These encompass disruptions to: (i) commodity markets (especially food and energy), (ii) logistic networks, (iii) supply chains, (iv) foreign direct investment, (v) specific sectors”. The disruption in the production and export of crops like wheat, corn, barley, sunflower seeds, and sunflower oil, and fertiliser and energy are estimated as follows: “Global income drops by 0.7 percent, with low-income countries losing 1 percent, driven by a contraction in global exports. Manufacturing exporters such as Vietnam, Thailand, and Mexico see a sharp decline, especially in energy intensive sectors. Net exporters of crops, such as Turkey, Brazil, and India, and of fossil fuels, such as Nigeria and countries in the Middle East, see a surge in their exports, attenuating the negative effects of the war”. “Trade-policy interventions risk making a bad situation worse. Export restrictions further reduce global supply, while import liberalization measures and subsidies increase demand. Since the beginning of the war, 53 new trade policies (67 including subsidies) have been imposed or announced. Export restrictions such as outright bans or licensing requirements account for 31 new measures. Export restrictions alone have added seven percentage points to the price of wheat and risk igniting a tit-for-tat escalation that could trigger a food crisis. Higher food costs take the biggest toll on net importers – largely low and low-middle income countries in Sub-Saharan Africa (Botswana, Zimbabwe) and the Middle East (Algeria, Tunisia) – deepening world poverty”.

The report notes “disruptions to global and regional supply chains have caused input shortages and price hikes. Sectors critically dependent on inputs from Ukraine include steel (iron ores, ferro silico manganese, and pig iron), heavy manufacturing (flat and rolled steel products), semiconductors (neon gas), cars (ignition cables), and software…Russia stands out as a supplier of primary and intermediate goods and services for other countries’ exports at an early stage of production. Transport equipment, machinery, electronics, and agribusiness are especially reliant on imports of Russian metals, chemicals, fertilizers, and other commodities”.

“European markets are the most vulnerable, with Moldova being the most dependent on imports from Ukraine. Within the European Union, Poland and the Czech Republic are most exposed to imports from Ukraine. Elsewhere, Turkey, Arab Gulf countries, Ethiopia, and Nigeria rely on Ukraine as a key supplier for some products, but overall, the exposure of non-European markets appears limited”. “Supply chain production hubs in China, Germany, and the United States are among Russia’s largest trade partners…The largest effects of trade disruptions would be felt by members of the Eurasian Economic Union (Armenia, Belarus, Kazakhstan, and Kyrgyzstan) and other members of the Commonwealth of Independent States. The war is expected to curb FDI in neighboring countries and in the energy sector. Armenia, Moldova, and the Kyrgyz Republic – where more than 20 percent of inward FDI is from Russia – could suffer from shrinking inflows of FDI and a contraction in their existing stock, an increase in capital outflows, and losses on their outward FDI in Russia. European countries including Finland, Germany, and Norway have large investments in Russia’s energy sector, and Europe is highly dependent on Russian oil and gas. The war’s direct impact on global FDI is likely to be muted because Russia and Ukraine play a limited role in global FDI networks. Indirect effects could prove more profound and far-reaching as elevated uncertainty and geopolitical risks damp investor confidence…Russia and Ukraine account for a large number of tourists in developing countries (ranked 6th and 38th globally in tourism expenditure). Countries including Georgia, Moldova, Montenegro, and Turkey are highly dependent on tourists from Russia and Ukraine…Countries that attracted large shares of tourists from Russia and Ukraine during the pandemic include Egypt, Tunisia, Thailand, Cuba, the Maldives, and Tanzania”.

Maria Grazia Attinasi, Rinalds Gerinovics, Vanessa Gunnella, Michele Mancini and Luca Metelli point out “war-related disruptions to production and trade flows from Russia may be amplified through global production networks given the country’s significant forward integration in global value chains. Russia’s share in global forward global value chains participation is around double the size of its share in gross global trade (2.8% versus 1.5%). Notably, Russia has one of the highest forward participation rates in supply chains, as more than 30% of its exports consist of inputs used by its trade partners as intermediate inputs, compared to a global average of just 18%. This is explained by Russia’s specialisation in energy and metal industries, which are intrinsically more forward integrated, being positioned upstream in the production process. Therefore, disruptions to Russia’s exports might well propagate downstream through supply chain networks, having an impact also via the indirect trade. Moreover, as Russian inputs are involved in several stages of production, implications of disruptions could potentially be long-lasting, in line with previous firm-level empirical evidence based on the Tohoku earthquake”. In addition, they note analysis showing that under weak substitutability conditions, “the magnitude of the effects on economic activity of disruptions to trade in energy products would be higher than estimated…and, in the case of a full energy embargo, they would increase markedly and may reach 4% of GDP in the euro area”.

The knock-on effect of sanctions is evident. For example, Anastasia Safronova notes “Russia is one of the world’s leading exporters of fertilizers. According to the Fertilizer Institute in the US, in terms of the global export market, Russia accounts for 23% of ammonia, 14% of urea, and 21% of potash, as well as 10% of processed phosphate exports”. In April, the EU sanctions “included a ban on the import of fertilizers – plus, vessels registered under the Russian flag were banned from EU ports…several major shipping companies… suspended services to Russian ports. In response, the Russian Ministry of Industry and Trade advised fertilizer manufacturers to halt exports, citing transport sabotage. All this has seriously affected the price of fertilizers”. “Washington made an exemption for Russian fertilizers…This step, however, is not enough to spare Americans from soaring prices…because of the global interconnectedness of the global fertilizer industry,”

Chris Heitzig, Aloysius Uche Ordu and Leo Holtz points out the sanctions are preventing “U.S. and eurozone banks, their foreign affiliates, and Russian banks based in the U.S. and eurozone countries from facilitating dollar and euro transactions on behalf of Russian entities. The problem for Africa is that roughly 95 percent of all trade is invoiced in these two sanctioned currencies alone and that a vast majority of Africa’s $14 billion trade with Russia is likely denominated in these two currencies”. They estimate “currency sanctions alone have the potential to disrupt 1.8 percent of all African trade and, for some countries, upwards of 5 percent of trade revenue”.

In the short-term, the economic war disrupts global finance, logistics and supply and aggravates shortages and inflationary pressures. Broadly, there is a massive transfer of resources from energy and resource importers like China, Europe and Japan to exporters like US, Russia and the Middle East. Steep food and fuel price increases will trigger social unrest in several countries. Tightening monetary conditions will transmit contagion. The debilitating effects becomes evident over time as the GEW contagion effects is slow-moving and severe.

In the event of decoupling between “democratic” and “autocratic” countries, Maeva Cousin, Tom Orlik and Bryce Baschuk estimate, assuming a blanket 25% tariff, that “global trade plunges by some 20%…falling back to its levels at the end of the 1990s, before China joined the WTO, as a share of GDP…All countries would have to shift resources toward activities they’re less good at. A chunk of the productivity that’s associated with trade would be lost. In the long term, a rollback of globalization to late-1990s levels would leave the world 3.5% poorer than if trade stabilizes at its current share of output, and 15% poorer relative to a scenario of global ties strengthening. The model shows that another 7% of existing trade relationships would shift between blocks. In concrete terms, that might mean factories making goods for US markets moving from China to, say, India or Mexico”.

Escalation into the Great Economic War (GEW)

We are in the beginning phases of the GEW. It is the pending escalation of the conflict into scenarios such as a nightmarish confrontation between the US with China that freezes the global economy and markets or a deepening rift between the Global South and West with conflicts erupting in various countries and domains. These scenarios may lead to hot disputes that spirals into a third world war.

My perspective is that the invasion of Ukraine provided the justification and the economic war was used as a platform for the US to solidify its once-divided European and Asian alliances. I would argue the strategic objectives are to (1) oblige European and Asian allies to cut their reliance on Russian energy, minerals and commodities.; (2) test run an economic war in a limited setting; (3) undermine political stability and maybe even achieve regime change in Russia. The GEW can be considered preparatory steps for the looming multi-dimensional confrontation with China. In this regard, the GEW sanctions are dramatically changing supply chain geography and fast-tracking decoupling with China. The next step must to leverage on GEW to revive “Western” power against China and “neutral” Global South countries.

This assumes the West can easily achieve its objectives. In reality, a long path of escalating conflict lies ahead. Russia’s advantage is that it has little choice but to bear the economic pain and focus on a narrow front – the Ukraine invasion and stabilising its domestic economy. In contrast, the West has more on its plate. It has to deal with domestic dissatisfaction as contagion from global spillovers spread. It has to juggle pressures for concessions from existing and potential allies.

Most of all, the West must achieve reasonable success in isolating Russia. It is early but the isolation campaign is already proving to be a mammoth task. From a strategic perspective, this may be the most opportune time for the US to strike. Russia is pre-occupied with Ukraine. In the meantime, the US has managed to solidify support from Europe. The US is therefore pressing China into making a lose-lose decision of choosing sides. If China sides with the West, this would alienate Russia. If China openly sides with Russia, Europe can be goaded into expanding the GEW to China. In my view, China sees the confrontation as inevitable and is buying time by hedging. The US dilemma is that it does not have time on its side and need to press home its advantage before its advantage dissipates and before the high costs of the GEW becomes apparent. But if it pushes aggressively, allies could resist as the costs of taking on Russia and China at the same time may be too heavy. Delaying gives time for China and Russia to strengthen their defences.

The US has threatened secondary sanctions but support from the Global South has not been forthcoming. The inability to enforce sanctions will result in a significant loss of Western credibility. These pressures are setting the stage for a breakout of geopolitical battles for control of access and resources throughout the world. As a matter of comparison, unlike in the 1950s Western MNCs no longer have a global monopoly. Global South firms (including Russian) are capable of filling the vacuum left by Western corporate exits.

Another potential miscalculation is the implicit assumption that the West could inflict damage on Russia with minimal impact on itself as it is protected by its wealth, technology and financial strengths and its broad alliances. But Russia is in a position to escalate by counterattacking Western interdependencies. In this regard, Russia has little left to lose and can go for broke by restricting the export of minerals and commodities such as neon, helium, crypton, aluminium, nickel, copper, sapphire substrates, titanium, uranium, lithium, cobalt, palladium, zinc, wheat and fertiliser. The outcome is dependent on which side is able to find substitutes for sanctioned products and activities and to bear the costs of the economic conflict. In addition, the war on interdependencies is more likely to affect the globalised economies in the West and China than a commodity-based economy like Russia. The global after-shocks include the impact of heightened risk aversion, food shortages, civil unrest and debt crises in several emerging countries and falling asset prices in developed countries.

Leonardo Dinic points out the West is counting on their strengths in global finance but “if China and Russia pivot the world to a multipolar order relying on industrial potential and commodities, financials will not matter as much”. Revaluing China’s economy based on exchange rates show “it is a $17.7 trillion economy to the U.S.’s $23 trillion. If we use PPP…the Chinese economy is at $27 trillion, meaning that it is 20 percent larger than that of the U.S. If we revalue it by diminishing the focus on the service sector, which stands at around 54.5 percent of overall GDP, we find that the Chinese economy could be about 30 percent of the world’s economy instead of the 18 percent…combine China and Russia…represent 35 percent of the world economy when using PPP and compensating for the over-valuation of the service sector. The U.S. is heavily services-oriented with 77 percent of the value in services with the EU at 70 percent focused on services, suggesting that the collective West might only represent about 25 percent of the world economy”. He concludes “when crises arrive, the world realizes how crucial commodities and the industrial sector are, while diminishing the importance of the services sector. This leads to a very precarious economic situation in the West, as outlier nations band together to become more resilient to Western sanctions. Just like Russia relies on industry and commodities, China can rely on manufacturing in the face of more aggressive Western sanctions. This means that the EU and U.S. are somewhat dependent because of their geographic positioning. Services are crucial to the EU economy and account for around 70 percent of the EU’s GDP, which means that the EU is dependent on commodities and manufactured goods from both Russia and China to make this economy work. This reality puts Eurasia in a decent position despite global instability caused by the war in Ukraine. Time will determine the macroeconomic and geopolitical realities in the post-war in Ukraine period, but it is not as grim for China or Russia as most media outlets would like you to believe”.

This reinforces the point that advanced economies are dependent on globalisation and services and they have the most to lose from deglobalisation. In addition, the West is counting on domestic re-industrialisation and re-locating existing supply chains to “friendly” developing countries. First, the reindustrialisation of developed service-based economies is an untested proposition and may not be feasible. Second, shifting supply chains from China to other developing countries will only end up accelerating the decline in Western share of the global economy.

The West also appear to have underestimated contagion effects from the combination of inflationary pressures and financial sanctions. The sanctions effectively increase policy uncertainties, compliance and legal risks, collateral shortages and counter-party risks. Heightened risk aversion leads to cross-border deleveraging, widening bid-offer spreads and ebbing global liquidity. Meanwhile, Western central banks find they are constrained in printing money to finance their deficits and compelled to raise interest rates and normalise their balance sheets. This is, in turn, triggering a collapse in asset prices and unleashing debt deflation dynamics.

Further escalation is possible in the near future, arising from legal or military conflicts to seize Russian or “sanctioned” assets even in “neutral” territories. In addition, while Russia is currently preoccupied with its invasion, it is unlikely to remain passive. In the future, it is likely to insist on the return of its “sanctioned assets and property rights and may target select countries for their failure to comply.

Conclusion: The Great Economic War (GEW) begins

The GEW is only at the beginning phases and ahead is the prospect of escalation and contagion. For Russia, the GEW poses an existential threat to its ruling regime. Russia has little to lose by going for broke. The US, and its Western allies may feel that if it doesn’t act forcefully now, they could lose their leadership position. The GEW will usher in a new order of geopolitical co-existence. If the rivalries are not managed through de-escalation and cooperation, the risks of a mutually destructive war would rise. But the GEW cannot be managed similarly to a military war as the main battleground is in the information realm.


Anatol Lieven, Sarang Shidore, Marcus Stanley (25 March 2022) “Avoiding the dangers of a protracted conflict in Ukraine”. Quincy Brief.

Anastasia Safronova (29 May 2022) “Hunger games: How the world’s farmers have become collateral victims of sanctions against Russia”. RT.

Benjamin Jensen (16 March 2022) “Preparing for the next phase of the Russian war”. Center for Strategic & International Studies (CSIS).

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Gilbert Doctorow (1 May 2022) “The Eagle Has Landed: A voyage to St Petersburg via the far side of the moon”.

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James Dobbins, Raphael S. Cohen, Nathan Chandler, Bryan Frederick, Edward Geist, Paul DeLuca, Forrest E. Morgan, Howard J. Shatz, Brent Williams (2019) “Overextending and unbalancing Russia: Assessing the impact of cost-imposing options”. Rand Corporation.

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[1] See Anatol Lieven, Sarang Shidore and Marcus Stanley; Mathew Burrows and Robert A. Manning; and Richard Haass.

[2] Tom Hill outlines key issues in negotiating a peace settlement.

[3] See Jeffrey Sonnenfeld for a list of companies exiting Russia.

[4] Monika Grzegorczyk, J. Scott Marcus, Niclas Poitiers and Pauline Weil details how sanctions on high-tech goods supplies, combined with financial sanctions and other restrictions, is affecting Russian industries. J. Scott Marcus, Niclas Poitiers, Pauline Weil analyses the decoupling of Russia from software, media and online services due to voluntary actions to exit Russia or restrictions imposed by the Russian government.

[5] Autarky refers an economy that is completely closed off and reliant on self-sufficiency.

[6] See Rand Corporation report on “Overextending and unbalancing Russia: Assessing the impact of cost-imposing options”. Dimitri A. Simes relates the history of the Russian economic collapse in the 1990s which influenced its economic policies.

[7] See

[8] See Wikborg Rein (9 March 2022) “Update on Russian countermeasures against so-called unfriendly states”.

[9] See Sergey Glazyev for a Russian economist’s perspective on the impact of Western sanctions.

[10] See Gilbert Doctorow’s account of on-the-ground conditions in St Petersburg.

[11] See Michele Ruta.