The Committee on Economic and Monetary Affairs of the European Parliament invited me to participate in a hearing on the consequences of EU sanctions against Russia. I attended on behalf of the Vienna Institute for International Economic Studies (WIIW), which focuses on Eastern Europe, from the Baltics to the Balkans, including Russia and Turkey. In this short adaptation of my contribution, I concentrate on the intended effects of sanctions on Russia, the unintended disruptive effects on other economies, the possible long-term consequences for the EU, and the potential global reconfiguration.
It is difficult to isolate the effects that sanctions on Russia are having on both Russia as well as other European countries, given that sanctions are always intertwined with other developments and reactions to the sanctions. Furthermore, we must differentiate between the short- and long-term effects as well as the direct and indirect effects of sanctions, which seem to be more important than the sanctions themselves. At the same time, Russia is imposing countersanctions in the area of hydrocarbons in particular, which can also be interpreted as a result of the sanctions.
Overall, the effect of sanctions on the Russian economy and Putin’s aggressive behavior has been less than predicted. The collateral effects on European economies - inside the EU and especially in the Western Balkans - have also been underestimated. Thus far, the disruptive effects have been managed well, but this may change with a drawn-out war or even stronger sanctions.
Russia
Evaluating the effects of sanctions on Russia is particularly difficult, as some statistics are no longer published in the country. The Russian economy has certainly been affected, but the WIIW - as many other research institutes - has revised its forecast upwards and reduced the foreseen decline in Russia’s GDP. The country’s trade balance has been improving due to import reductions without equivalent reductions in exports. Nevertheless, Russia’s economy will remain in recession for the next year. The most negative effects seem to be the withdrawal of Western companies with their technological know-how and the emigration of highly-educated young people who oppose the war and/or want to avoid being conscripted.
Russia has thus far been relatively successful in finding alternative ways to import necessary goods for consumption and investment, but its “parallel” imports and its trade diversion towards Asia are costly and of lower quality. Still, Russia has managed to keep the dissatisfaction of its citizens relatively in check. Some financial compensation in combination with nationalist propaganda and severe disciplinary measures will continue to discourage stronger resistance to the war.
However, high military spending and the additional government expenditures to mitigate the negative effects of sanctions have put a heavy burden on the country’s budget. Russia is still in a relatively solid financial position given increased revenues as a result of high oil and gas prices - despite the reduction in total exports. The EU restrictive decision concerning oil exports may change this.
Nevertheless, well-known experts such as Vladislav Inozemtsev argue that mobilization will change the situation, as it will create labour market disruptions: “The current Russian government has shown itself incapable of managing a modern war, and the Russian economy is the price the Kremlin must pay. Therefore, I would contend that this second act of the war (or rather, this transformation of the “special military operation” into a full-scale war) will eventually kill off the Russian economy.” (WIIW Monthly Report October 2022)
Ukraine
The collateral effects of sanctions against Russia on Ukraine have been overshadowed by the effects of the war itself. However, Ukraine has shown a strong and united effort to reject Russia’s aggression through military means, and at the same time it has demonstrated a surprisingly strong economic resilience so far.
Together with strong support from the West, it has adjusted its economy to war conditions. Therefore, the recent forecast for 2023 shows a modest recovery.
However, Russia’s increased attacks on critical infrastructure - especially energy infrastructure - could cast doubt on the positive evaluation of the autumn forecast. In any case, Ukraine will need strong economic support from the West for years to recover. Any reconstruction plan must be well-designed and organized. Moreover, it appears that Ukraine has, even in a time of war, shown continued efforts to battle corruption, which creates a positive basis for a more successful recovery.
Turkey
Turkey has sought to avoid falling victim to sanctions on Russia. In fact, it can even be seen as a country benefiting from trade diversions and “parallel” imports to Russia: it has helped to substitute goods that are affected by sanctions - directly or indirectly - by facilitating trade. The fact that Turkey has declined to follow Western sanctions and helps Russia to bypass some sanctions provides Turkey with the opportunity to act as a mediator, especially concerning grain exports. However, the economically “positive” effects have not prevented Turkey from facing heavy economic problems, including the highest inflation rate of all the countries observed. The weak lira will not help to reduce inflation in the longer term.
Eastern Europe and the Western Balkans
There is no consistent impact of sanctions on the countries of Eastern Europe and the Western Balkans, but rising inflation has become a critical issue for the countries of this region. Increased prices are further compounding the inflation that began after Covid as a result of increasing demand outpacing production and supply. In addition, higher gas and oil prices are spreading across economies throughout the region, with lower-income individuals most affected. As food prices are also rising especially fast, countries with a higher dependence on imported food - normally countries with lower national incomes - suffer more[pm1] severely. This is primarily the case in the Western Balkans, Hungary, and Slovakia. General inflation is especially high in the Baltic countries, North Macedonia, and Hungary.
Increasing energy prices also put a heavy burden on countries that depend on energy imports. Even countries that can in certain seasons export energy have to import energy - at higher prices - in other seasons.
Another factor in the region is higher interest rates, which have broken out of their decades- long downward trend. This creates more problems for housing markets – which again disproportionately impacts lower-income individuals. This comes in addition to increased housing expenses due to rising electricity and gas prices. The steep increase in interest rates also reduces the possibility for companies to access credit at reasonable costs for necessary investments. Finally, it reduces the ability of governments to borrow money to finance compensation measures that support lower-income individuals. Thus, fiscal policy faces significant constraints due to high interest rates.
The countries in Eastern and Southeastern Europe that are heavily dependent on exports to Western Europe - especially to Germany - are particularly vulnerable to a recession as a result of production closures triggered by energy shortages or drastic price increases.
At the same time, there has been hesitation to invest in countries close to Russia or the war. In this regard, Moldova has been particularly effected by the negative consequences of the war and as a result of its total dependence on Russian energy.
A special case is Serbia, as it has also declined – thus far – to join sanctions against Russia. Serbia is in a relatively good position economically and has an inflation rate that is among the lowest in the region. In addition, real wages are rising. However, Serbia has seen a reduction in foreign direct investment (FDI) from both Russia and the West. The big question is how Serbia will continue to position itself in relation to Russia on the one side and the West - especially the EU – on the other side. For the moment, there is no clear activity supporting trade diversions or “parallel” imports to Russia in order to bypass sanctions.
The economic and social consequences that bring hardship to many people in Europe’s weaker economies also carry a political dimension. Russia could use these effects to strengthen its “moral” position in these countries. The EU must therefore strengthen its own activities in the Western Balkans in particular to prevent Russian - or other - disruptive activities. The policy goal of making the EU independent from Russian gas and oil imports should therefore include the Western Balkans.
Conclusions
The EU
Overall, economies have proved far more resilient to the effects of sanctions on Russia than previously expected. This is equally true for both Russia and Ukraine. However, it is too soon to come to final conclusions. The big question remains how these two countries that have been for many years closely connected – both politically and economically - can live side by side in the future after Russia’s aggression.
Inside the EU and the Western Balkans, the consequences have differed greatly, depending on different countries’ respective energy situations and their dependence on Russian gas and oil. In general, lower-income individuals are suffering more as a result of rising energy and food prices. At the same time, governments face fiscal constraints to help because of rising interest rates that limit their borrowing capacity. This is also true for industries that are suffering from rising energy prices and interest rates. As a result, the possible destruction and/or outflow of industry and employment to the US and/or some Asian countries is a danger that must not only be carefully watched but also counteracted. For the moment, the war in Ukraine and the sanctions on Russia with their many unavoidable consequences are weakening the EU, at least on an economic level. Moreover, the reconstruction of Ukraine will require a strong financial contribution from the EU.
The British historian Timothy Garton Ash said in a recent talk celebrating the 25 year anniversary of the European Council on Foreign Relations (ECFR) that the “Post Wall Period” - which ended the “Post War Period” came to an end with the Russian attack on Ukraine. Mark Leonhard added: We can no longer believe that trade as such brings people together or makes war impossible. The same is true for the internet and the existence of global challenges such as climate change. Defending EU values and interests requires a comprehensive security policy, from protecting and securing strategic goods and production to military strength.
In this respect, one of the most important tasks that the EU faces is to end colonialism inside wider Europe. This means that Russia must lose its war against Ukraine. This, in turn, must lead to a wider Europe in which the Western Balkans as well as Ukraine, Moldova, and Georgia are integrated in a way not yet known and hopefully with a renewed decision structure of the EU as such.
A new global world?
One of the main long-term issues is how sanctions will reshape the global system. Will these sanctions help to create new global economic/political blocs that will be in opposition to each other in a new kind of cold war? If so, will this entail a China-Russia bloc with few allies and a US-EU block with hopefully more allies? In such a scenario, would Europe permanently play an economically minor role in relation to the US, as Russia would in relation to China, or can it find a more equal role - economically, politically, and concerning its approach to fundamental rights?
In addition to these two global blocs, there would be several bigger and many smaller “neutral” or “non-aligned” countries, with India, Turkey, Brazil, and others in the lead. How could they be won over with a better understanding of the West’s values and approach towards global issues? They are themselves very different in their domestic and foreign policies, but they may refuse to further align themselves with one of the two new blocs. The West - and the EU in particular - should engage itself more with these countries with the goal of reducing discrepancies in income, wealth, and environmental degradation in order to prevent conflicts. (This point was underlined by Ivan Krastev in the aforementioned ECFR event)
What does this new bloc-building mean for addressing the most urgent issues, from decarbonization and climate neutrality to combating famine and poverty? And how could disarmament and especially nuclear non-proliferation be brought to the negotiation table again?
It is because of these issues and the need not to lose sight of other urgent global challenges that Western dialogue with China is of the utmost importance. The fact that dependence on Russian oil and gas did not prevent Russia’s aggression should not necessarily lead to disruptions in economic and political links to China. However, one-sided dependencies must be reduced as soon as possible, and Chinese investments in the EU should be carefully screened and scrutinized. At the same time, global alliances with like-minded countries should be strengthened and new ones established. They should not weaken international institutions and multilateral activities, but instead strengthen them. The question will be whether the new blocs, while confronting one another, can agree on some basic global policy issues and seek solutions.
Dr. Hannes Swoboda, President of the International Institute for Peace (IIP), started his career in urban politics in Vienna and was elected member of the European Parliament in 1996. He was Vice President of the Social Democrat Group until 2012 und then President until 2014. He was particularly engaged in foreign, enlargement, and neighborhood policies. Swoboda is also President of the Vienna Institute for International Economics, the Centre of Architecture, the University for Applied Science - Campus Vienna, and the Sir Peter Ustinov Institute.