Economics of war: Pain for Europe now, later for Russia

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Across Europe, signs of distress are multiplying as Russia’s war in Ukraine drags on. Food banks in Italy are feeding more people. German officials are turning down the air conditioning as they prepare plans to ration natural gas and restart coal plants.

A giant utility is asking for a taxpayer bailout, and more may be coming. Dairies wonder how they will pasteurize milk. The euro has sagged to a 20-year low against the dollar, and recession predictions are on the rise.

Those pressure points are signs of how the conflict — and the Kremlin gradually choking off natural gas that keeps industry humming — provoked an energy crisis in Europe and raised the likelihood of a plunge back into recession just as the economy was rebounding from the COVID-19 pandemic.

Meanwhile, high energy costs fueled by the war are benefiting Russia, a major oil and natural gas exporter whose agile central bank and years of experience living with sanctions have stabilized the ruble and inflation despite economic isolation.

In the long run, however, economists say Russia, while avoiding complete collapse, will pay a heavy price for the war: deepening economic stagnation through lost investment and lower incomes for its people.

Jessica Lobli, a single mother of two from the Paris suburb of Gennevilliers, pays close attention to surging grocery prices. She’s reduced her consumption of milk and yogurt and renounced Nutella or branded cookies.

“The situation will worsen, but we need to eat in order to survive,” said Lobli, who earns between 1,300 and 2,000 euros per month working in a school kitchen.

Her monthly food budget of 150 to 200 euros dropped to 100 euros in June. She said her family doesn’t eat as much in summer, but she’s concerned about September, when she will have to buy school supplies for her 15-year-old daughter and 8-year-old son, further whittling her budget.

French President Emmanuel Macron says the government aims to conserve energy by switching off public lights at night and taking other steps. Similarly, German officials are begging people and businesses to save energy and ordering lower heat and air-conditioning settings in public buildings.

It follows Russia cutting off or reducing natural gas to a dozen European countries. A major gas pipeline also shut down for scheduled maintenance last week, and there are fears that flows through Nord Stream 1 between Russia and Germany will not restart.

Germany’s biggest importer of Russian gas, Uniper, has asked for government help after it was squeezed between skyrocketing gas prices and what it was allowed to charge customers.

Carsten Brzeski, chief eurozone economist at ING bank, foresees a recession at the end of the year as high prices sap purchasing power. Europe’s longer-term economic growth will depend on whether governments tackle the massive investments needed for the transition to an economy based on renewable energy.

“Without investment, without structural change, the only thing left is to hope that everything will work as before — but it won’t,” Brzeski said.

While Europe is suffering, Russia has stabilized its ruble exchange rate, stock market and inflation through extensive government intervention. Russian oil is finding more buyers in Asia, albeit at discounted prices, as Western customers back off.

After being hit with sanctions over the 2014 seizure of Ukraine’s Crimea region, the Kremlin built a fortress economy by keeping debt low and pushing companies to source parts and food within Russia.

Though foreign-owned businesses like IKEA have shuttered and Russia has defaulted on its foreign debt for the first time in over a century, there’s no sense of imminent crisis in downtown Moscow. Well-heeled young people still go to restaurants, even if Uniqlo, Victoria’s Secret and Zara stores are closed in the seven-story Evropeisky mall.

The successor to McDonald’s, Vkusno-i Tochka, is serving more or less identical food, while the former Krispy Kreme in the mall has rebranded but sells basically the same offerings.

In less well-off provinces, Sofya Suvorova, who lives in Nizhny Novgorod, 440 kilometers (273 miles) from Moscow, has felt the squeeze on the family budget.

“We practically do not order takeaway food anymore,” she said while shopping at a supermarket. “It used to be very convenient when you have small children. We go to cafes less often. We had to reduce some entertainment, like concerts and theaters; we try to keep this for children, but adults had to cut it.”

Economists say the ruble’s exchange rate — stronger against the dollar than before the war — and declining inflation present a misleading picture.

Rules preventing money from leaving the country and forcing exporters to exchange most of their foreign earnings from oil and gas into rubles have rigged the exchange rate.

And the inflation rate “has partially lost its meaning,” Janis Kluge, an expert on the Russian economy at the German Institute for International and Security Affairs, wrote in a recent analysis. That’s because it does not account for disappearing Western goods, and lower inflation probably reflects sagging demand.

Some 2.8 million Russians were employed by foreign or mixed ownership firms in 2020, according to political scientist Ilya Matveev. If suppliers are taken into account, as many as 5 million jobs, or 12% of the workforce, depend on foreign investment.

Foreign companies may find Russian owners, and protectionism and a glut of government jobs will prevent mass unemployment.

But the economy will be far less productive, Kluge said, “leading to a significant decline in average real incomes.”