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22 May 2022

The West and the rest

The pandemic and the war taught me something I sort of knew, but not really. It is a one thing to say that the world is interconnected, as a cliché. It is quite another to observe what actually happens on the ground when those connections get torn apart.

The western sanctions were based on a formally correct but misleading premise, one that I believed myself at least up to a point: That Russia is more dependent on us than we are on Russia. Russia has more wheat than it can eat, and more oil than it can burn. Russia is a provider of primary and secondary commodities, on which the world has become dependent. Oil and gas are the biggest sources of Russian export revenues. But our dependency is most acute in other areas: food and also rare metals and rare earths. Russia is not a monopolist in any of the categories. But when the largest exporters of those commodities disappears, the rest of the world experiences physical shortages and rising prices.

Russia is the world largest exporter of gas, accounting for just under 20% of global exports. Russia is the largest exporter of oil, after Saudi Arabia, and accounts for 11% of world exports. It the largest exporter of fertilisers, and of wheat. Russia and Ukraine together account for almost a third of global wheat exports. Russia is the world’s largest exporter of palladium, a metal that is critical in the production of catalytic converters and fuel cells. Russia is also the largest world exporter of nickel, which is used in batteries, and in the production for hybrid cars. German industry is warning that it is reliant not only on Russian gas, but on other critical supplies from Russia.

Did we think this through? Did the foreign ministries that drew up the sanctions discuss at any point what we would do if Russia were to blockade the Black Sea and not allow Ukrainian wheat to leave the ports? Did we develop an agreed-upon response to Russian food blackmail? Or did we think we can adequately address a global starvation crisis by pointing the finger at Putin?

The lockdown taught us a lot about our vulnerability to supply chain shocks. It has reminded Europeans that there have only two routes to ship goods en masse to Asia and back: either by container, or by rail through Russia. We had no plan for a pandemic, no plan for a war, and no plan for when both are happening at the same time. The containers are stuck in Shanghai. The railways closed because of the war.

Economics sanctions work when the target is small: South Africa in the 1980s, Iran, North Korea. Russia is much larger. The relevant size indicator is not GDP. In terms of GDP, Russia is the size of the Benelux countries, or Spain. The GDP metric ignores network effects.

Those networks effects are sufficiently large to render the instrument of economic sanctions unsustainable. Alternative sources exist for each and every one of those Russian commodities, but if you cut world supply by a permanent 10, 20 or 40%, depending on the commodity, you cannot physically generate the same output that we generate now at the same prices. The economy reacts through higher prices and falling demand and supply.

I have concluded that we are all too connected to be able to impose sanctions on each other without incurring massive self-harm. You may argue that it is worth it. If you do, you sound like the tenured economics professor who argues that a rise in unemployment is a price worth paying.

Putin is dependent on western supplies too. The rise in oil and gas prices, and the fall in Russian imports from the rest of the world, has brought a windfall dollar gain to his economy, but he cannot easily spend the money. The Russian economy will suffer a severe slump. That is not in doubt. The direct impact of the sanctions on Russia will be bigger than on us. But that comparison, too, is a false metric. What counts is the difference between the impact and our respective pain thresholds. Putin’s is much higher.

I can only see a single scenario in which the imposition of economic sanctions would work to our advantage: if we managed to get rid of Putin, and he is replaced by a pro-western democratic leader. That may well be the US administration's ultimate war aim, but it is a long shot. Even a military defeat of Russia would not necessary trigger a new Russian revolution. The broken network problem would persist.

Unless we cut a deal with Putin, with the removal of sanctions as a component, I see a danger of the world becoming subject to two trading blocs: the west and the rest. Supply chains will be reorganised to stay within them. Russia’s energy, wheat, metals, and rare earths will still be consumed, but not here. We keep the Big Macs.

I am not sure the west is ready to confront the consequences of its actions: persistent inflation, reduced industrial output, lower growth, and higher unemployment. To me, economic sanctions look like the last hurrah of a dysfunctional concept known as the west. The Ukraine war is a catalyst of massive de-globalisation.

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