Western sanctions on Russia and Russia's counter-sanctions hurt the EU as much as they hurt Russia
This article originally appeared at Gordon Hahn's Blog
In November the European Union’s (EU) policy towards Ukraine helped spark the greatest international crisis in Europe since World War II. EU refusal to coordinate its eastward expansion with Moscow, especially to Ukraine, gave greater impetus to the already intensifying Western-Russian ‘great game’ for hegemony over that divided country and the remaining non-aligned states in Eastern Europe and to Russia’s south.
The watershed in the winner-takes-all game for Eastern Europe was made inevitable by NATO expansion begun in 1997 and destined to come in Ukraine, with its geostrategic importance, significant population, market, natural resources, and long-standing ties with Moscow.
The Ukrainian showdown was made even more inevitable, if you will, and imminent by the 2008 NATO summit’s declaration that Ukraine and Georgia would one day become NATO members, followed months later by the Georgian-Ossetiyan/Russian war and Russia’s route of the NATO-trained Georgian army.
By supporting an illegal seizure of power spearheaded by neo-fascists groups within the larger Ukrainian pro-Western opposition and potentially revolutionary movement and in clear violation of a Russian-EU brokered transition pact to resolve the regime crisis, Washington and Brussels through down the gauntlet before the Kremlin.
With this, Russian President Vladimir Putin had little choice but to salvage Russian interests and annex Crimea – home to its Black Sea Fleet and a population 80 percent ethnic Russian in favor of reunification with Russia – in answer to Washington’s Kiev demarche. For similar strategic and ethnopolitical reasons Putin also had little choice but to back the Donbass revolt against Kiev.
Effectively countered as in the 2008 Georgian debacle, the West could ill afford another geopolitical defeat at Russia’s hands or direct military conflict with Moscow. Therefore, the West changed tactics and initiated economic sanctions directly against Russia. Moscow responded with lesser sanctions against the West; the war evolved into a semi-frozen conflict after two Minsk ceasefire agreements, and there we stand.
The problem with any set of sanctions is that it prevents two, not one, from tangoing. Any trade relationship is a two-way- street. Stop one party from trading, and that party’s trade partners suffer no less. The comparative advantage lies in the potential that the target country of any sanctions regime suffers from each denied or cancelled contract, while the pain on the other side is divided up among many countries.
However, in the case of the sanctions against Russia, Europe is carrying the brunt of the regime implementation. It has more trade with Russian than any other entity implementing the sanctions. By contrast, the promoter of sanctions against Russia, the U.S., has very little trade with Russia. The American industry with the largest percentage export to Russia is the chicken industry, exporting 8 percent of its produce to Russia, the industry’s second largest buyer.
The EU’s economy might be seen as divided into 28 separate economies, but that reality went out the window with the EU’s formation. Europe has created a common market and political union, and therefore the strain of implementing the sanctions regime settles in good part on the EU, not the individual EU member country level.
It is well-known that Russia has suffered from Western sanctions, though most economists, east and west, agree that the brunt of the hit on the Russian economy has not been the sanctions but rather the fall in oil prices. Less well-known is the shambles Ukraine’s economy has been left in as a result of the civil war and Ukraine’s declining volume of trade with its closest trading partner – Russia.
Even less well-known is the substantial cost of sanctions to Europe’s economy. There were dire warnings from reputable economic and trade analysts that mutual sanctions could spark a global recession. “The worst case scenario could be very dark—surging energy prices, crumbling stock prices, and much weaker trade and foreign direct investment,” said Mark Zandi, chief economist at Moody’s Analytics, in 2014.
The Boomerang Effect
Der Speigel called the hit on Germany’s economy taken from the sanctions’ “boomerang effect,” but it is really more like cutting a bungie cord held by two people; it snaps back on both sides to hit both of the people holding it on the nose. What has been the effect of the West’s sanctions on Russia on the EU’s economic performance? Regarding the former, almost all economists agree that the bulk of the Russian economic downturn is due to falling price of oil and indeed that the decline began in 2012 – before the Ukrainian crisis – with the fall in the oil price.
Similarly, while there other factors contributing to Europe’s economic deceleration – bureaucracy, the Greece crisis, falling Chinese demand – a major cause is the set of mutual sanctions between Russia and the West intensely involving the EU. By 2014 most of Europe’s largest industrial sector (manufacturing, energy, high technology) companies were experiencing contract cancellations, planned cancellations of contracts or projects with Russian companies, and declining Russian demand as a result of the Western-imposed sanctions. Companies included: Adidas, Siemens, EagleBurgmann, RhineMetall, Fraport, Daimler, retailer MetroAG . The list shows (all but Adidas are German companies) that the driver of the EU economy, Germany, was perhaps the most exposed, conducting a disportionate share of EU trade with Russia.
Sweden reported losses of 1.5 billion crowns in just the first quarter of 2015 as a result of the sanctions, including the rejection of 89 applications for export to Russia, including coal mining, construction, and lumber industry as a result of Russia’s retaliatory sanctions and broader effort to rely on its domestic market through an aggressive import-substitution policy.
Russia’s Agriculture Sanctions
By far, the most serious consequences of Russia’s reverse sanctions have been felt in European agriculture. In August 2014, Russia embargoed several categories of food products from the European Union, the United States, Canada, Australia and Norway, including dairy, beef, lamb, pork, vegetables, and fish.
Prior to Russia’s ban, EU agriculture held 80 percent of Russia’s dairy market. EU Agriculture Commissioner Phillip Hogan said in August that Russia’s ban on imports on EU dairy had led to a slump in demand and sharp drop in payments to EU dairy farmers.
French pig farmers estimate that Russia’s embargo has led to a loss of almost a billion euros. Germany’s large agricultural sector is taking a hit; German cheese prices have hit a six year low.
Eastern Europe’s largest economy, Poland, has been hit by Russia’s agricultural produce embargo. Warsaw saw its control of Russia’s apple import market completely eliminated, prompting Polish officials to accuse France of undermining European solidarity over Paris’s then planned sale of two Mistral warships to Russia and other trade arrangements. That issue was ‘resolved’ when Russia decided to cancel the warship deal and demand return of $ 1.2 billion euro payment.
The Dairy and Milk Crises
A general milk crisis has been sparked, though theRussian embargo is not the only factor in its making; EU milk deregulation and overproduction and declining exports to China are also factors. Deregulation through the lifting of national quotas for milk production has created a common but declining milk industry in combination with Russia’s dairy embargo. The German Farmers’ Union estimates that the Russian embargo accounts for 20-30 percent of the recent decline in global milk prices to a 30 year low.
Less diverse and powerful EU economies have been hit even harder. Radio Sweden warned last month of a global milk crisis, noting that “the current crisis is regarded as one of the most serious in the last 40 years.” The current price of 2.65 krona (about 30 cents US) is below the 3.60-3.70 krona (41-42 cents) necessary for Swedish dairy farmers to make a profit, and four out of five may face bankruptcy if the situation does not improve over the next six months.
In Denmark, 86 percent of farmers are facing a “similar” “critical situation” to those in Sweden, according Association of Swedish Farmers Jonas Carlsberg, who complained it was wrong “that farmers must pay for political decisions.” Sweden’s milk producer Arla reported 1 billion Swedish crowns in losses in August 2014 alone.
Czech dairy farmers have lost export of 500 tons of butter and 1,500 tons of powdered milk to the Russian market. The Baltic states’ entire dairy industry could collapse. Estonia has seen a 30 percent decline in producer prices, with its milk exports falling by 17 percent in the first quarter of 2015.
Lithuanian agriculture has faced a 30 percent year-on-year decline in exports in mid-2015. Local experts warn Lithuania may be forced to reduce the production of dairy products by 50 percent in the near future.
The hits taken by individual EU members can redound to the EU as a whole. Thus, Vilnius is set to appeal to the EU Agriculture Commissioner for 32 million euros to bolster its agriculture industry. In general, Lithuania is the country most vulnerable to Russian sanctions, where exports of the Russia-banned agricultural products comprise 2.5% of the country’s GDP.
When sanctions began, the EU estimated that by themselves its Russia sanctions, initiated well into 2014, would take 0.2-0.3 percent points bite out of EU economic growth that year alone. Therefore, they should take at least 0.3 percent points in 2015 (no estimate available yet). Add in Russia’s sanctions against the EU, and we should be talking about a full one percent hit on the EU economy in 2015. A recent EU projection sees its own economic growth for 2015 at an anemic 1.7 percent. This is a dismal outlook and not so very far from recession.
At the same time, the EU projected Russia’s growth rate would fall by 0.6 percentage points from the expected growth rate to 1 percent growth in 2014 and fall by 1.1 percentage points producing 2% economic growth in 2015 as a result of EU sanctions alone.
By more recent estimates, the Russia’s GDP is set to contract by 3.6 percent, the median forecast of 40 economists in a Bloomberg survey, and grow by 0.5 percent in 2016 (Anna Andrianova and Olga Tanas, “Russia Faces Reality With Prediction of Deeper Economic Slump,” Bloomberg, August 25, 2015). But again, much of this is the result oil price decline, not Western sanctions. It is also a result of the boomerang effect from its own sanctions against the West.
In June, the Russian government extended the embargo until August 2016 in response to the EU’s extension of sanctions against Russia. Ukraine’s depression, Russia’s recession, anemic European and American growth, war across the Muslim world, and now China’s economic crisis are all effecting energy demand and consequently oil prices.
In particular, the Ukraine-centered Russian-West sanctions war is playing a key role in falling energy demand, further hitting the Ukrainian and Russian economies. This requires more Western bailouts for Ukraine and threatens more Russian sanctions against the West and so on and so on.
In sum, although the West appears to have been hit less by the sanctions regimes tha has Russia, it has taken a significant hit, particularly in Europe and some its weakest economies. So the West has scored a technical win. Ultimately, however, the sanctions have produced a political draw – recall Putin’s astronomical approval ratings – that is hardly able to force the Kremlin to surrender Russian national interests and security in Ukraine.