A New World Emerges from the War in Ukraine – the Economic and Geopolitical Stakes
The world prior to Russia’s invasion of Ukraine belongs to the past.
We must understand the complexities of this rapidly evolving world if we are to make informed choices about how to plan for the future.
In February 2022, Putin launched an aggressive campaign to defeat Ukraine, while intimidating the Western powers and undermining NATO, which he claimed was losing ground, with the aim of reviving a powerful Russia reminiscent of the former Soviet Union, of which Putin would be the Czar.
But in June 2023, none of this happened: the Ukrainians, remarkably resilient, ubermotivated and well-trained, resist with the latest military technologies supplied by the West, while the EU reasserts its authority; and NATO is stronger then ever... It's unlikely that Putin will ever become the tsar of a Russian empire under the favorable auspices of China, and this is in an international context where Russia is increasingly perceived as a pariah.
Russia’s grip on Europe
Before Russia invaded Ukraine, the European Union imported 74% of its natural gas and 60% of its oil from Russia, according to the International Energy Agency. Exports of gas and oil were Russia's primary economic interaction with the West.
For many decades – from the days of the Soviet Union to Russia's invasion of Ukraine – Europe and Russia concluded a marriage of convenience over hydrocarbons. With the result that Europe became heavily dependent on Russian energy, especially natural gas. Meanwhile, Europeans enjoyed direct access to energy supplies via pipelines, limiting their dependence on unreliable sea deliveries from the Middle East, while the Russians sought a stable market for their oil and gas exports.
After the fall of the Soviet Union, EU leaders felt that keeping Russia as its energy supplier was the best strategy, both to ensure Russia's economic stability and to strengthen Europe's influence: its status as a major customer was intended to dissuade the Russians from giving in to their worst impulses. In reality, Russia's massive gas exports have made it even more powerful.
Europe’s shift : bye-bye Russia, hello Uncle Sam
The European response to Russia's blackmail over energy prices, which rose by 28%, and to the interruption of Russian gas deliveries was threefold: firstly, to reduce demand (businesses and households cut their natural gas consumption by more than 20% in 2022); secondly, to look for gas elsewhere; thirdly, to accelerate the transition to renewable energies.
Liquefied natural gas (LNG) from the United States currently represents 60% of EU LNG imports. The cost of converting gas to a liquid form and transporting it means that the price of LNG cannot compete with that of dry gas delivered by pipeline. However, the multiplication of LNG terminals in the EU, following the German model, and the rise in imports will bring prices down, especially in view of lower demand from China, still grappling with the effects of the COVID-19 pandemic.
Nuclear power, is receiving renewed attention as a reliable, long-term source of zero-emission energy. EU countries such as Germany have now delayed planned closures, while France and the UK continue to build nuclear power plants.
In the long term, the combination of demand reduction, increased efficiencies, optimized use of LNG and renewable energies will enable Europe to significantly reduce its reliance on Russian gas. At the same time, the EU is committed to never again be dependent on cheap Russian hydrocarbons. As to Russia's political influence, it will be weakened by the loss of its position as Europe's primary gas supplier.
The energy crisis significantly slowed the recovery from the pandemic
Prior to Russia's invasion of Ukraine, the OECD projected global economic growth at around 5% in 2022. However, the conflict proved to be ‘a massive and historic shock’ to the global economy, slowing economic growth to just 3.1% in 2022 and 2.2% in 2023, according to the OECD in its November 2022 report. The European economy was expected to grow by just 0.3% in 2023.
The invasion and the sanctions imposed on Russia sparked a surge in energy prices on a scale not seen since the 1970s. This crisis disrupted global trade that was still recovering from the pandemic. Its impact was felt most acutely in the energy and food sectors, squeezing supply, and driving up prices to unprecedented levels.
The war has sent prices soaring for 3 basic necessities. They are the basic elements of Maslow's Hierarchy of Needs: warmth, food and shelter. Higher heating bills reflect surging energy prices; rising food prices attest to Russia's and Ukraine's role as the world's leading exporters of wheat and fertilizers; while housing costs are up sharply compared to pre-war levels – all of which are taking a heavy toll on everyone's livelihood, although the effects will be felt most acutely by the less affluent.
Global defense spending surges
The Ukraine crisis bolstered Europe's resolve to stand united in the face of new geopolitical realities and threats posed by Moscow's regional ambitions. It has prompted a fundamental review of the European Union's defense systems, and a joint commitment to a substantial increase in the Union's defense budget.
To date, 15 NATO countries, along with Sweden and Finland, have joined the alliance in an historic shift, led by the United States.
Most European countries responded with significant increases in their defense budgets, most notably Germany committing to 2% of its GDP. Similarly, the budget of the European Peace Facility (EPF) – an off-budget funding mechanism for EU military and defense-related actions – hardly used before the war in Ukraine, has provided €2.5 billion in cash and military equipment for the defense of Ukraine.
On top of the war in Ukraine, the perceived threat from China has spurred Europe and its allies to step up their military spending. China's ambitions in the Indo-Pacific region are worrying the West, especially the United States. While analysts doubt that an invasion is imminent, the CIA warns that China has plans to seize Taiwan by 2027; the world is watching closely. It's conceivable that Ukraine's resilience and the sanctions faced by Russia could serve as a ‘live simulation’ of how an invasion of Taiwan might play out, giving Beijing pause for thought.
Recreating the Cold War economy
The current situation virtually recreates the Cold War division of the global economy in certain sectors. While Russian gas and oil exports will not return to pre-invasion levels, Russia remains the world's leading exporter of wheat and forestry products, as well as a major source of strategic resources such as nickel, cobalt, uranium and platinum. However, it is now at a greater disadvantage, since it no longer operates in the larger space of the Soviet bloc, whose former members are now part of the European Union and NATO.
Regardless of the outcome of the war, Western companies will be reluctant to rush back to Russia or invest there in the future; and while the Russians can survive without Gucci or McDonalds, their exclusion from Western technology will have an impact on the manufacture of their high-tech products.
Russia will also suffer from not having access to Western financial markets and institutions, including the worldwide payment messaging system SWIFT.
Deglobalization pressures mount
The war in Ukraine once again exposes some of the risks associated with the interconnected nature of global trade. Whereas the pandemic already highlighted the vulnerability of just-in-time supply chains, the economic fallout from the war in Ukraine further accentuates the risks inherent in such systems, leading to structural changes in supply chains.
The global economy is not dead, but the war has set in motion a dynamic that is reshaping the global business landscape. As companies become increasingly conscious of trade risks, cost savings will be scrutinized more closely against risks. This reappraisal of profitability versus risk will drive longer-term transformations of global supply chains, in the form of reshoring or nearshoring.
The intensification of deglobalization will result in higher prices, at least in the short term, temporarily exacerbating inflationary pressures. But this process is more likely to be gradual than sudden, and will affect different sectors in different ways.
International experts agree that the fallout from Putin's war will not mark the end of globalization, but rather the advent of a new kind of globalization. It's highly unlikely that globalization will be reversed without vigorous government intervention.
Corporate players take a stand – Investors leave
The war has had direct effects on firms operating in Russia and Ukraine and firms relying on suppliers from those markets. Of the 281 Fortune 500 companies that were present in Russia before the war, close to 70% have either scaled back or exited their Russian operations since the start of the war. Almost 85% of companies headquartered in Europe or the United States have left or scaled back, against only 40% of those based in other regions. The exodus is not confined to any one sector.
The corporate reaction came swiftly. Some decisions were announced within days of the invasion and the first round of sanctions. More than ever, fundamental management choices are influenced by a wide range of stakeholders beyond investors, including employees and customers.
The war will have lasting economic and geopolitical consequences. It proved to be a ‘massive and historic shock’ to the global economy, on top of the devastating effects of the pandemic. But there is no going back. The survival of Putin’s regime now depends as much on the outcome of the war as the survival of Ukraine.
The vigor and scale of the 'unprecedented' economic sanctions imposed by the West exceeded Moscow's expectations. Although Russia briefly benefited from a rise in gas and energy prices, the sanctions struck at the very heart of the Russian financial system. The departure of thousands of companies, from Apple to McDonald's, coupled with a mass exodus of Russian citizens fleeing the country, led to a ‘brain drain’ in an already ailing economy. A commercially isolated and weakened Russia has fallen captive to China's control, and runs the risk of becoming vassalized. Once again, the world is polarized: tensions exist between the West and China, with Russia relegated to the sidelines.
By contrast, Europe has become more influential on the international stage. Meanwhile, trade dynamics have changed fundamentally, exposing the fragility of global supply networks. As global trade reorganizes, factories are increasingly relocalizing and recentring. This intensified deglobalization will lead to higher prices in the short-term, temporarily exacerbating inflationary pressures. At the same time, the impact of global warming remains unpredictable, adding to the complexity of the current situation. Luckily, Europe's sustained efforts to accelerate the transition from carbon energies to renewables offer promising prospects for a brighter future.