RRussia’s invasion of Ukraine, and the sweeping sanctions the US and Europe have imposed on Russia in response, have unleashed economic disruption on four levels: direct, backlash, spillover, and systemic. To mitigate their longer-term consequences, we must start work on recovery plans now.
Of course, the Ukrainian and Russian economies are hit the hardest. Economic activity in Ukraine is expected to contract by well over a third this year, exacerbating the rapidly escalating humanitarian crisis. The war has already led to this more than 750 civilian casualties and driven 1.5 million Ukrainians are fleeing to neighboring countries, and millions more are on the move internally.
While Russia is not suffering major human suffering or physical destruction, its economy will also shrink by about a third due to the unprecedented severity of the sanctions it is now facing. In particular, the freeze on central bank assets and the exclusion of select Russian banks from Swift, the financial messaging system that powers most international bank payments, are bringing the economy to its knees with “self-sanctions” by households and businesses. from Apple to BP, compounding the damage.
Russia is now heading for severe currency restrictions, massive commodity shortages, a collapsing ruble, mounting arrears and household expectations that things will get worse before they get better. This image has a lot in common with what I saw when I visited Moscow in August 1998.
Even if the war ended tomorrow, it would take years for these economies to recover; and the longer the war lasts, the greater the damage, the greater the potential for vicious circles and negative cycles, and the deeper the consequences.
In Ukraine, the physical and human infrastructure has been hit very hard. The country can count on massive external support for reconstruction in order to work through past weaknesses and build new economic structures and relationships at home and abroad. But the process will take time and there will be obstacles along the way.
For Russia, for its part, it will be very difficult to restore economic, financial and institutional ties with the outside world, especially with the West. This will hamper the eventual economic recovery, which will depend on the implementation of a series of complex and costly internal restructurings with institutional, political and social dimensions.
But the economic consequences of the war will not be limited to the countries fighting it. The West has already begun to feel the backlash of ‘stagflation’. Existing inflationary pressures are compounded by rising commodity prices, including energy and wheat. Meanwhile, another round of supply chain disruptions has begun, and transportation costs are rising again. Disrupted trade routes are likely to put further pressure on growth.
The extent of the damage these developments will cause will vary widely both between and within countries. Without a timely policy response, advanced economies should expect slower growth, worsening inequality and widening performance differentials across countries. Overall, the US is likely to outperform Europe, which is likely to slip into recession due to the US economy’s greater internal resilience and agility, despite the Fed’s failure to respond to inflation in a timely manner over the past year – a historical policy error – will undermine political flexibility.
Expect heightened – and at times worrying – market volatility on both sides of the Atlantic. Financial losses will be greater in Europe, with certain sectors – notably certain banks and energy companies – being hit very hard.
Elsewhere in the world, too, economic and financial divergence will increase. Some commodity producers will benefit enough from higher export prices to offset the losses caused by slower global growth. But a far greater number of countries – particularly those located close to contested and fragile developing countries – will face pressures from a variety of sources, including unfavorable trade conditions, migration flows, a strengthened US dollar, weaker global demand and instability in the global economy financial markets.
Commodity importers will face sudden, generalized price increases that are both difficult to pass on to consumers and difficult to subsidize. The potential impact could include further debt restructuring. If policymakers fail to act in a timely manner, the weakest economies face food riots.
Then there is the future of multilateralism, the fourth fallout. In the short term, the West has reasserted its dominance over the international system it built after World War II. But there should be a serious longer-term challenge from an intensification of China-led efforts to build an alternative system one economic or financial brick at a time.
It is often said that in every terrible crisis lies great opportunity. While it is imperative that countries continue to come together to confront Russia’s illegal invasion of Ukraine, it is also vital that they take timely action to mitigate the longer-term economic risks the conflict poses – and even to strengthen future resilience and collaboration.
After World War II, the world showed itself up to the challenge. Our focus now is to ensure a similar response once peace returns to Ukraine and Europe.
Mohamed El-Erian is Allianz’s Chief Economic Advisor. He served as Chairman of Barack Obama’s Global Development Council and is a former Deputy Director of the IMF.