What are the lessons from Russia/EU Decoupling?
The great crash that wasn't
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When Russia commenced its invasion of Ukraine in February of 2022, more than a few commentators noted the apparent anachronism of it all. A full-scale conventional war between powers that were, it turned out, near-peers, lasting more than a few weeks? Such a conflict hadn’t been seen since perhaps the Iran-Iraq war, and there were myriad questions (and predictions) about how the war would impact its participants and the rest of the world. When the war did not quickly end, many assumed that mounting EU sanctions and Russian retaliation would wreck both economies. After all, they were deeply intertwined before the war - over a third of Russian trade occurred with the EU, and Russia was the EU’s largest source of fossil fuels prior to 2022.
This was not only an important economic question: liberal theories of international relations have often appealed to the “Kantian Tripod” of democracy, international law, and commercial interdependence to create peace. A major argument for continuing open trade, even with countries that are not democracies or particularly inclined to follow international law, has been that economic interdependence would make war so costly that both sides would go out of their way to avoid it. The Center for Strategic and International Studies is only one of many institutions to take essentially this line when dealing with the question of trade barriers in geopolitics, arguing for Kant’s assertion that “The spirit of trade cannot coexist with war, and sooner or later this spirit dominates every people”. Clearly the economic interdependence between Russia and the EU (and it is really the EU, and not Ukraine, that had the capacity to harm the Russian economy) did not forestall hostilities entirely. However, it would be some vindication of the logic behind the theory of the Russian and European economies were devastated by the severance of their economic interconnection.
The results have been far less dramatic than many predicted. While some predictions (Glenn Beck confidently declaring that EUROPEANS WILL FREEZE) probably shouldn’t have been taken too seriously, even more levelheaded publications like The Economist seriously contemplated the chances of a truly horrific winter - and likewise the expectation that Russia’s economy would face a massive collapse turned out to be largely unfounded as well. Some of these results were due to unforeseeable circumstances - a very warm winter in Europe, for example. But the results of this (hopefully) once in a generation event tell us a great deal about what modern interconnected economies look like and especially what leverage they do - and do not - provide countries over one another, and call into question the idea that trade interdependence makes war unthinkable.
There were several key areas where economic collapse was expected but not forthcoming. Energy is a massive one, but food (for both Europe and the world generally) and manufacturing (within Russia) were also expected to take major hits - so it’s valuable to look at each and see what happened and what can be learned.
Energy
Energy has been the most extensively analyzed. German energy prices hit a massive peak in August (peak air conditioning season in a very hot summer), briefly topping 650 Euros per Megawatt Hour - over ten times higher than most 2021 prices. The rest of Europe followed a similar pattern. The TTF natural gas benchmark also zoomed to new heights in August. Both prices have fallen precipitously since then, however - electricity prices are comparable to 2021 and natural gas prices are well below where they were immediately prior to the outbreak of the war.
This was possible for two reasons: the expansion of liquified natural gas markets, and the explosion of alternative energy, which managed to soften the blow falling on European manufacturing. First, natural gas is a unique market compared to other fossil fuels. As its name implies, it is typically in a gaseous state, which is rather difficult to transport; lacking pipeline infrastructure, in fact, it is often not used at all but simply ‘flared’ off. These leads to dramatically different markets for gas. Delivering Mexican oil across the Pacific costs about $5/barrel, or roughly 7%, more than delivering it to the US West Coast. By contrast, natural gas in North America is roughly 1/5 the cost of gas in the Far East or in Europe. However, the technology to liquify natural gas so that it can be shipped across oceans without a pipeline is improving. Europe’s imports of liquified natural gas (LNG) were about 60% higher in the post invasion period of 2022 than they were in the same period in 2021; much of this was fed with rising US exports, as the US surged into position as the world’s largest LNG exporter. The LNG market is diversified, however, with Europeans importing from the Middle East, Russia, and Africa as well. Thus, one major lesson from 2022 is that LNG capacity worldwide seems likely to make natural gas markets more like markets for oil, greatly reducing the ‘tyranny of proximity’ which Russia had exercised over Europe.
The other portion of the story is renewable energy and a focus on conservation. Even before Russia’s invasion, Europe was sourcing over 1/3 of its energy from renewable sources, and in 2022 the continent increased its goals for renewable power. Wind and solar power set records in Europe, making up to an extent for difficulties in maintaining French nuclear capacity. As with LNG capacity, the ability of states to pivot to renewable energy greatly reduces the potential leverage the grant to their fossil fuel suppliers.
On the other side of the coin, Russia initially benefitted from higher energy prices, with its revenue for gas and oil spiking. However, it now faces an extended period of diminished revenue, with overall fossil fuel income falling to levels not seen since the height of COVID lockdowns. This is due to a decrease in pipeline sales to Europe (a decrease largely initiated by Russia itself), an inability to shift into liquifying most of its natural gas, and a steep drop in oil prices for sanctioned Russian oil. Russia thus finds itself in a situation somewhat like the Confederate States during the US Civil War: what it had thought was its trump card - for Russia oil, for the South, cotton - was suddenly much less powerful, due to technological advances and the diversification of the global supply.
Food
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The other major concern related to both Russia and Ukraine as major producers of food, especially grains, and fertilizer. There was an initial jump in wheat prices as it became clear that Russia was going to be blockading the Ukrainian coast, and there were concerns that sanctions on Russia would make insuring Russian freighters and financing wheat sales too difficult. Again somewhat laughable predictions (Pro-Russian ‘journalist’ Gonzalo Lira warning of a fivefold increase in bread prices), but also much more grounded concerns about the price and availability of food both in Europe and in Africa and the Middle East.
Instead, these fears again turned out to be unfounded. Russia had warned that sanctions would bit into its exports, and many opponents of those sanctions repeated the same - but looking back on the year it turns out Russia’s grain exports hit new records in terms of volume, including during periods of heightened wheat prices. In other words, Russia profited nicely from its temporary disruption to the global food market.
Ukrainian wheat exports, by contrast, did slip, but not by as much as expected. While it appeared initially that Russia would be able to blockade the Ukrainian coast and would choose to do so, the sinking of the cruiser Moskva, flagship of the Black Sea fleet, in April made clear that from a military perspective operating near the Ukrainian coast was not going to be easy for the Russian navy. Possibly for this reason - or possibly because of the fear of greater sanctions or blockades of its own enclave in Kalingrad - Russia agreed to a deal that would allow Ukrainian grain to be loaded on the Black Sea and sent to Istanbul, and from there sent onwards. Even in periods where the deal was suspended, Ukraine was able to export some grain from its ports, like that in Izmail, which can be accessed primarily through Romanian waters.
This meant that by autumn global wheat prices had stabilized at pre-war levels - however, there was consumer pain in Europe as bread prices were about 20% higher in December of 2022 than they had been the previous year, a rise nearly double the background inflation rate in Europe over the course of the year. For the developing world, the picture is mixed. While the grain deal did allow for at least some delivery of Ukrainian grain to food insecure areas like Ethiopia, the war still contributed to an overall increase in food instability and drop in food affordability. In a few countries, such as Egypt, this was particularly noticeable and threatened to explode into a full blown crisis. Given the increase in Russian grain exports, it seems unlikely that this is primarily or even notably due to sanctions - instead, the war itself has disrupted supplies. A sad reality, then: the disruption due to war has apparently been most devastating to countries largely uninvolved with the conflict.
Manufacturing
In the early months of the war, Russia was expected to lose substantial manufacturing capacity as European and American brands pulled their investments. Initial indications suggested a complete collapse in the automotive industry and some expected the same in other branches of heavy manufacturing. This has not been the case, however. By and large, Russian manufacturing has been weakened but not seriously inhibited by sanctions. Its true that it went from a couple percent year-over-year growth to a couple percent year on year decline since the war began, but the results have hardly been the catastrophe that was expected.
Part of the reason has been that Russia is largely self sufficient in the raw materials needed for industry, and many of the assets that were shuttered by the departure of western firms were in fact simply transferred to new Russian entities. For goods that cannot be made in Russia, particularly highly advanced computer chips, there are other avenues: imports through Turkey, China, and other states have been able to fill much of the gap. There may well be longer term ramifications, as Russia struggles to maintain key capital goods like aircraft and turbines, but for now the Russian industrial sector seems capable of operating with only a slight diminution of productivity.
In Europe the impact on manufacturing is even less clear - in some months, manufacturing grew relative to 2021, while in others it fell - with power prices likely a major culprit. Major German manufacturers like Bosch and Siemens - companies with theoretically large exposure to the Russian economy - continued to pull in profits in 2022 despite losses in assets due to sanctions. Overall, the EU ended 2022 with slightly lower unemployment and a slightly larger GDP than it entered with. Even the big economic story of the crisis - inflation - appears to be leveling in both the Eurozone and Russia.
Interdependence is insufficient for peace
Of course, this is all with a sample size of one - we cannot run a controlled experiment to know if another war involving interdependent trade blocs would have the same impacts. But what evidence it does provide suggests that simply increasing trade links with countries that are not dedicated to international law nor subscribe to a liberal democratic mode of governance is not a sufficient deterrent to conflict, as belligerents (or, in the case of the EU, quasi-belligerents) may be better than predicted at dodging the worst effects of conflict. Findings, like those by Russet and O’Neal that form the basis for much contemporary liberal international relations theory, that the three elements in conjunction do increase the chances of peace should be read with this in mind.
What to do with this information is another question, but it seems to at least to a degree vindicate decisions like strategic computer chip exports restrictions to states such as the People’s Republic of China. Those strategic materials are likely to end up assisting rival war machines (as western parts have demonstrably done in Russia) without creating the sort of peace-supporting interdependence that was hoped, or granting the manufacturing states as much leverage as they seek. Furthermore, it points to the insufficiency of thicker international trade networks to make up for the weakening of international norms and rules in the face of the American invasion of Iraq and Russian invasion of Ukraine. If the ‘Kantian Tripod’ is to be our ticket to peace, much more emphasis will have to be placed on strengthening the legs of liberal democracy and international institutions.