Impact of the Ukraine War on the Global Economy

Tatsuhiko Yoshizaki

1. What is Happening to the Global Economy?

How will the Ukraine war change the global economy? It is anything but easy to answer questions about the current crisis.

First, let us review the latest edition of the IMF's World Economic Outlook (WEO). 1 The newest WEO, "War Sets Back the Global Recovery," released in April of this year, revised a preceding economic outlook dated January sharply downward. Wary of the expansion of the Omicron variant and US interest rate hikes, the January WEO still bullishly forecasts the global economic growth rate at +4.4% for 2022 and +3.8% for 2023. Yet, the April edition revised the previous outlook to +3.6% for 2022 and +3.6% for 2023, respectively. These downward forecasts clearly reflect the impact of the Ukraine war.

In particular, the recent WEO expects the Russian economy to register a significant negative growth of 8.5% this year --- a downward revision of 11.3 percentage points from the previous forecast, taking into account the impact of severe economic sanctions imposed by Western countries against Russia. The Eurozone, close to the battlefields and accepting many Ukrainian refugees, is expected to register a 2.8% economic growth, deteriorating by 1.1 percentage points.

Meanwhile, the US economy, self-sufficient in terms of food and energy, is expected to grow at a relatively high rate of 3.7%, down only 0.3 percentage points. On the other hand, the Japanese economy, a typical "have-not" economy, is projected to grow by 2.4%, a downward revision of 0.9 percentage points. A comparison between advanced countries and emerging countries indicates that larger downward revisions are observable for the latter.

Looking at the overall picture, the historical rule of experience seems to apply: "War makes everyone unhappy, but it especially hits the weak."

2. Current Situation --- Five Overlapping "Emergencies"

However, the "Ukraine war" is not the only factor to be analyzed in the current global economy. Over the past three years, the global economy has faced the following "emergencies" one after another. Five challenges have come at the same time. Each of those crises occurs in linkage with the others --- "Misfortunes never come singly but in battalions."

Next, let us review the five emergencies now weighing on the global economy.

(1) Once-in-a-century pandemic (since spring 2020)

The pandemic caused by the "novel coronavirus infection" that first broke out in Wuhan, China, has just entered its third-year phase. It appears to have peaked out in Europe and the United States. But a large-scale lockdown took place in Shanghai from April to May of this year.

(2) Inflation in the United States and Europe for the first time in 40 years (since summer 2021)

Facing the economic downturn caused by the Corona pandemic, governments responded with massive monetary easing and fiscal spending. The effects of these measures led to an unexpected consumption boom in the United States, which in turn caused disruptions in international logistics, such as container shortages. Since the summer of 2021, consumer prices in the United States have risen by more than 5% on a year-on-year basis and reached an 8% level from March to April this year.

(3) US Fed shifted to a tight monetary policy (since autumn 2021)

Initially, the US Fed explained that "the price hikes are transitory," but from the fall of 2021, it began to take serious steps to counter inflation. Since the FOMC meeting in March of this year, the US Fed has raised interest rates consecutively, intending to carry on monetary tightening. Since this spring, declines in stock prices and the appreciation of the US dollar in foreign exchange markets have become noticeable.

(4) Unexpected outbreak of war (since February 2022)

Then came the Russian invasion of Ukraine. Some point out that President Vladimir Putin's choice of armed aggression resulted from his prolonged isolation under the Corona pandemic, which adversely affected his ability to judge as a leader. 2 The outbreak of war has given rise to new sources of anxiety for the global economy, such as a further surge in energy prices and food crises.

(5) Western countries unleashed economic sanctions against Russia (since March 2022)

Western countries respond to "Putin's war" with economic sanctions of an unparalleled scale. They have also taken unprecedented measures to exclude Russian financial institutions from the Society for Worldwide Interbank Financial Telecommunication (SWIFT) and to freeze the foreign exchange reserves of the Russian central bank.

3. Impact of Economic Sanctions --- More Serious than War

Of the above five emergencies, this paper will focus on (4) the Ukraine war and (5) economic sanctions by the West. However, to look at the global economy as a whole, it will also discuss factors of (1) through (3).

As of this writing, the Ukraine war has continued for more than three months. Many consider its prolongation inevitable, and on May 19, the US government decided on an additional $40 billion aid budget for Ukraine. This means that the $13.6 billion emergency package approved by Congress in March has already been disbursed; that the United States will continue to provide Ukraine with arms and ammunition, incurring enormous military expenditures.

The current battle in Ukraine is conducted in a 20th-century mode of warfare, using tanks and infantry as the main forces. Unless weapons of mass destruction such as tactical nuclear weapons are employed in the future, its impact on the global economy will remain limited.

A further pressing problem is that grain exports from Russia and Ukraine --- primary grain-producing countries --- could be hampered by the war. Russia and Ukraine account for 17.7% and 8.0% of the wheat export market, respectively; the two together account for close to a quarter of the world market (2020). In an ordinary year, grains shipped from the port of Odesa are exported to the Middle East and North Africa; but the Black Sea is currently blocked by mines laid by both sides in the war. Exports of Ukrainian grains by land routes and through ports of neighboring countries have been attempted; an estimate says that only 20% of the total volume may be transported in this way. 3

Another problem is that silos in Ukraine are full of last year's crops, and there is no room to store a new harvest. In addition, the wartime situation limits the amount of crops to be planted the following season. The problem of food shortages could become even more acute in the coming year and beyond.

Economic sanctions rather than the war itself will have a large impact on and raise uncertainty in the global economy. Sanctions are a diplomatic tool that do not involve military action; historically, there are many examples, from Napoleon's blockade of the European continent to the Trump administration's tariffs on Chinese products. However, their track record is not always good. 4 Countries subject to sanctions, such as North Korea, Iran, and Venezuela, are unlikely to say, "We're beaten," no matter how much their economies are damaged; therefore, regime change rarely occurs the way the sanctioning side expects.

Economic sanctions are difficult to use for the following three reasons:

  1. Their effects cannot be ascertained by either the sanctioning party or the sanctioned.
  2. The sanctioning party may also suffer some damage; therefore, it is unavoidable that some of its members try to gain an advantage over the others in minimizing their damage.
  3. The sanctioning party often loses sight of "the time to stop," and sanctions are prolonged in many cases.

On February 26, two days after the outbreak of the Ukraine war, the six Western countries imposed severe financial sanctions against Russia. Those sanctions appeared to be effective, as the ruble plunged in the immediate aftermath. However, after Russian Central Bank Governor Nabiullina announced bold measures to defend the ruble, the Russian currency's exchange rate against the dollar almost returned to its pre-war level by the end of March. There are no "immediate means to incapacitate the Russian government to carry on the war;" economic sanctions will take time to have their intended effect.

The main targeted item for sanctions against Russia is energy, including oil and natural gas. Reportedly, the Russian government's revenue from energy exports amounts to $1.1 billion a day. As long as this financial source remains intact, Russia is unlikely to experience difficulty financing its war effort.

Economic sanctions against such a resource power as Russia are unprecedented. Western countries are attempting to restrict imports from Russia of 1) coal, 2) oil, and 3) natural gas, in that order. However, a stable energy supply is nothing but national security for any country. Hungary, among others, depends on Russia for energy supplies to meet nearly 80% of its domestic energy needs. Even within the EU, it is not easy to reach a consensus on the "derussianization" of energy.

It would be even harder to cut off the natural gas supply from Russia. There are some voices in the EU that state that natural gas may be procured in the state of liquefied natural gas (LNG) from other areas. But such a form of procurement would surely be more expensive than the current one by pipeline, while EU ports lack the capacity to receive LNG vessels. It is also doubtful that the United States and other LNG exporters have sufficient spare production capacity.

What makes matters more complex is the international goal of "carbon neutrality by 2050" set at COP26 last year. If "decarbonization" is a realistic goal, OPEC and other oil-producing countries must hesitate to invest in oil and natural gas production. Their oil fields will unquestionably become stranded assets in 30 years.

The international community must prioritize "derussianization" over "decarbonization." Eventually, it is logical to hope that the time will come when all the world will depend on renewable energy. Yet, this will not happen soon. In the process leading up to that point, every nation will have to be busy securing fossil fuels for immediate need.

The absence of momentum to expand the circle of sanctions against Russia is another difficulty. At the G20 Finance Ministers and Central Bank Governors' Meeting held on April 20, the members were split 10-10 over whether or not to participate in sanctions against Russia. Those participating in the sanctions were the G7 nations, Australia, South Korea, and the EU. The remaining ten countries include, first and foremost, Russia, four of the pro-Russian "BRICS" (Brazil, India, China, and South Africa), and five countries (Argentina, Mexico, Turkey, Saudi Arabia, and Indonesia holding the G20 Presidency) who are non-participants in the sanctions.

A similar situation occurred at the APEC energy ministers' meeting held in Thailand on May 21-22, 2022. The moment that the Russian representative began to speak, representatives from five countries, including Japan and the United States, left the meeting as a sign of protest. 5 However, other participants from 21 economies (including Taiwan and Hong Kong) stayed on. The pros and cons of sanctions against Russia are dividing the world.

The G20, APEC, and other international forums attended by Russia are becoming dysfunctional. In the meantime, the Russia-free G7 is becoming increasingly important, but it should be noted that the G7's hard-line stance toward Russia has not won the consent of emerging countries. The G7 does not necessarily represent global economies.

Today, many if not most of the emerging countries are facing difficulties: the COVID-19 pandemic and inflation, for example. Some countries need to defend their currencies depreciated due to food crises and a strong dollar. Current account deficits are widening in many energy-importing countries. It is not advanced countries but emerging countries with vulnerability in economic fundamentals that are more susceptible to war.

Consequently, they want advanced countries not to increase risks for them any further with sanctions against Russia. Needless to say, Russia's armed aggression against Ukraine is disruptive to the international order. But did Russia not perpetrate similar things in Afghanistan and Syria? Is it not a "double standard" of the West to give particular attention to Ukraine? As the only G7 member in Asia, Japan's diplomacy should be sensitive to the feelings of those emerging countries.

It is not only the Western governments that tend to be "forward-leaning" in their sanctions against Russia. Some international public opinion presses global corporations to "exit the Russian market."

The Yale School of Management runs a website that monitors business with Russia. 6 Professor Jeffrey Sonnenfeld and his team, whose research focuses on corporate social responsibility, are rating global companies on their curtailment of business operations in Russia. They give the following "ratings" to companies doing business in Russia.

Yale CELI (Chief Executive Leadership Institute) List of Companies (as of May 31)

  • A-rated: Withdraw (337 companies)
  • B-rated: Suspension (460 companies)
  • C-rated: Scaling Back 154 companies
  • D-rated: Buying Time 161 companies
  • F-rated: Digging in (252 companies)

Source: The Yale School of Management website "Almost 1,000 Companies Have Curtailed Operations in Russia --- But Some Remain"

Professor Sonnenfeld tweeted, "If companies won't boycott Russia, boycott the companies." 7 The breakdown of the 252 companies categorized as grade "F (failing grade)" is as follows: 41 are Chinese companies, followed by 33 from the United States, 26 each from France and Germany, 15 from Italy, 13 from Japan, and 12 from India.

This website is updated frequently to reflect changing conditions. Some have noted that there is "lobbying" against the website by the listed companies. For global corporations, the "reputation risk" of continuing their business in Russia cannot be ignored. Therefore, platformers like Google and Apple and consumer goods companies like McDonald's and Starbucks have decided to exit the Russian market in a row.

Nevertheless, some companies are indifferent to such pressure: among the 41 F-rated Chinese companies are public sector giants such as Agricultural Bank of China, China Construction Bank, China Mobile, Air China, and China National Petroleum Corporation, as well as cutting-edge private companies such as Alibaba, Tencent, Haier, ZTE, and Vivo. When Western companies withdraw from the Russian market one after another, if these Chinese companies remain and continue the business, the damage to the Russian economy will remain minimal.

Economic sanctions are effective when used as a "deterrent," but when used as a "punishment," they are accompanied by grave difficulties. Since the economy is a living thing, it produces unintended consequences.

For example, trade with Russia accounts for only 1.0% of Japan's exports and 1.8% of its imports (2021). However, a total suspension of trade with Russia would be another question. For example, Japan's building material industry is already substantially affected by the war-caused reduction of wood imports from Russia. Russian softwood, excellent in strength, is used to produce strong plywood by gluing its thin sheets with similar sheets of domestic wood. Currently, there is a nationwide shortage in Japan of such plywood due allegedly to meager imports of Russian softwood via China.

Things are different for a country like the United States, self-sufficient in energy and food, but a "have-not" country like Japan should be more cautious in participating in sanctions.

4. The Global Economy after the Ukraine War

As mentioned earlier, the global economy is facing five unstable factors: (1) the COVID-19 pandemic, (2) inflation, (3) monetary tightening, (4) the Ukraine war, and (5) economic sanctions. It is hard to forecast its future. The following is the post-war outlook envisaged by the author.

#A short-term outlook: 1 to 2 years ahead

  • Energy price hikes and food shortages will continue. Some emerging countries will fall into an economic crisis due to a combination of problems such as the resurgence of the Corona pandemic, inflation, and currency depreciation.
  • The G20, the APEC, and other international forums attended by Russia will become dysfunctional. The importance of the G7 will increase, but its confrontation with emerging countries will not end.
  • The Russian economy will continue to shrink and weaken. However, thanks, in part, to conservative fiscal management, it will take a long stretch of time before Russia loses its capability to conduct war.
  • The US economy will enter a brief recession before the US Fed's tight monetary policy succeeds in curbing inflation.
  • The European economy will have a hard time regaining its pre-Corona strength due to the increasing burden of the "derussianization" of energy and the acceptance of refugees.
  • Fettered by its "Zero Corona" policy, the Chinese economy will have difficulties subduing the Corona pandemic. The Xi Jinping regime will be maintained, while the possibility of a "Taiwan contingency" will stop being imminent.

#A medium-term outlook: 3 to 5 years ahead

  • The COVID-19 pandemic will have subsided at last. The Ukraine war will cease, and the postwar peace process will begin.
  • The Russian economy will be exhausted, and Russia will be obliged to agree to a ceasefire. However, economic sanctions against Russia will not be lifted. Resource exports to China will barely provide a lifeline for the Russian economy.
  • The US economy will be back on a self-sustaining recovery path; many years of lack of demand since the international financial crisis of 2008 will be solved thanks to economic overheating amid the Corona pandemic. The United States will become a driving force for the global economy.
  • Difficult times will last for the European economy. On the other hand, huge investments will be directed to the reconstruction of Ukraine. The European Bank for Reconstruction and Development (EBRD), established after the Cold War, will be given an active role to play.
  • The Chinese economy will re-emerge. China will seek its world order with a feeble Russia as a junior partner and intensify its military rivalry with the United States.
  • "Decarbonization" programs will become stranded by a lack of investment, and international efforts to address climate change will delay. Meanwhile, fossil fuel prices will stay high.
  • Trade controls will be intensified, not only for high-tech products but also for resources and food. The "US-China decoupling" will advance, although not to the extent that the era of globalization will end.

The Japanese economy will achieve a certain level of economic growth with the "end of the Corona pandemic." But it will feel the misery of the "have-not" on many occasions as its trade deficit increases and the yen depreciates. It will play only a subordinate role in international moves to end the Ukraine war and economic sanctions against Russia.

5. Conclusion: Analogy with the 1920s

The above "five emergencies" confronting the global economy today will come to an end all at once when they do. Then a situation may appear similar to what happened exactly 100 years ago, following the cataclysm of World War I (1914-1918) and the Spanish flu pandemic (1918-1920).

The 1920s in the world are comparable to a warm autumn day amid the war-torn 20th century: the "Roaring Twenties" in the United States, the Weimar Republic in Germany, and the "Taisho Democracy" in Japan. The United States, in particular, enjoyed its prosperity; the economic boom lasted until the Great Depression of 1929. New products such as radios, telephones, and Model T Ford debuted, great skyscrapers soared high, and American popular culture flourished in the "Jazz Age."

The generation who came into the limelight during this period were those who spent their youth during the "war and pandemic" years, such as Charles Lindbergh (1902-1974) and Ernest Hemingway (1899-1961).

The present author sincerely hopes that in a new "post-pandemic and war" era that will dawn soon, humanity can witness a generation change and a period of economic prosperity comparable to each of them a century ago.

(Chief Economist, Sojitz Research Institute, Ltd.)

(Translation by Tsutomu Inuzuka)

current topics