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Global Economy

How war affects the economy

It is already becoming apparent that the Russian invasion of Ukraine could slow down the recovery of the global economy from the consequences of the Corona crisis. Despite Russia's comparatively low economic output, the international economy is dependent on the autocratically governed state. "A complete isolation of Russia could also hit the rest of the world economically hard. Every sanction against Russia is also a sanction that harms the rest of the world," says Klaus-Jürgen Gern, an expert on international developments in the economic team at the Kiel Institute for the World Economy (IfW Kiel) in conversation with tagesschau.de.

Because Russia is only the eleventh largest economy in the world and thus even has a lower per capita income than Italy. Russia's gross domestic product is just a tenth that of China. "From an economic point of view, Russia is a developing country that lives from the export of raw materials," says the expert from IfW Kiel. But that is exactly what worries economists like Gern: "Europe and Germany in particular are extremely dependent on Russian gas. And further economic development is decisively influenced by gas and oil prices."

Natural gas prices at record high

This is also confirmed by Thomas Obst, economics expert at the German Economic Institute in Cologne (IW): "We have been observing a sharp increase in gas prices for some time: before the pandemic, the price per megawatt hour was between 15 and 20 euros. Since the pandemic, especially by the end of 2021, it has risen to more than 70 euros."

This development was once again decisively driven by the Ukraine war: Yesterday, prices per megawatt hour for Dutch gas futures traded on the Title Transfer Facility (TTF) rose by more than 50 percent at times. Oil prices also rose: the price for a barrel of North Sea Brent rose to a high of more than 100 US dollars. Because after the Russian invasion, investors fear a shortage, if not a suspension of Russian raw material supplies.

A lack of gas could throttle production

"If you assume the extreme scenario, i.e. the complete stop of gas supplies from Russia, then this will mean that companies in Europe will have to reduce their production," judges Klaus-Jürgen Gern from the IfW Kiel. Because the rising prices are a problem for energy-intensive industries in particular, they are dependent on gas for production and, in case of doubt, have to pay the higher prices.

"Sooner or later, these price increases will also be passed on to end consumers and thus further fuel inflation," explains the expert from the IW. Inflation is already at a record high, and further increases will further weaken consumers' purchasing power. An end to the price spiral is not in sight for the time being. This endangers the economic upswing, which was initially indicated after the winter with the end of the omicron wave becoming apparent. Because the order books of industrial companies are full, if the supply chains relax, production could run at full speed.

Central banks could raise interest rates earlier than planned

As a result of rising inflation, the central banks could also be forced to intervene earlier than planned. "The ECB meeting is on March 10th. I'm very curious to see how the currency watchdogs will react to the new developments and whether they will decide to raise interest rates. The Ukraine conflict is presenting them with an even greater challenge between a subdued economy and higher inflation expectations at the same time," like fruit.

The US Federal Reserve has already reacted and announced that it will take current developments into account in upcoming interest rate decisions: The effects of the Russian attack on the US medium-term economic outlook would also be taken into account to determine the appropriate speed of interest rate hikes, said the head of the Federal Reserve District of Cleveland, Loretta Mester. In the US, too, many believe that events in Ukraine could exacerbate inflation and hurt economic growth in the short term.

China's reaction remains to be seen

Because, along with Europe, the USA is also dependent on Russian raw materials: "The USA imports large quantities of Russian oil," explains IfW expert Gern. The country does have a strategic oil reserve, explains Thomas Obst from IW: "The USA could also continue to increase production with fracking. However, it is difficult to assess whether they could use this to compensate for a potential lack of Russian exports to Germany."

According to the experts, China's positioning also plays a decisive role in the development of the global economy: "So far, China has been noticeably reticent. However, China does not actually have any convincing economic interests in siding with Russia," Obst judges. Moritz Kraemer, chief economist at Landesbank Baden-Württemberg, agrees: "China doesn't take Russia seriously as a partner. The two countries are simply too unequal." Foreign trade with Europe and the USA is much more important for the People's Republic than trade with Russia. "And I think it's very unlikely that China will want to bear the economic consequences of joining forces with Russia," said Obst.

Zero Covid causes problems

In addition, China is already struggling with more far-reaching problems due to its zero-Covid strategy, says Obst: "I think it is unlikely that the closure of public life can continue to be enforced with every corona outbreak in view of the omicron wave."

In any case, the experts assume that the Ukraine conflict will not have the same economic effects as the corona pandemic: "The consequences of the zero-Covid strategy, which is associated with closed ports and delivery bottlenecks, are significant for the global economy," Thomas judges Fruit. The IfW expert Gern also agrees: "We will probably experience a longer phase of uncertainty and also a renewed abandonment of globalization, because crises like these reveal the vulnerability of the economic system."

Ukraine war could only be a short break

Moritz Kraemer goes even further in his judgement: "The Ukraine war will only be a short break in the global economy's recovery from the Corona crisis and the supply bottlenecks. But there will be no long-term consequences." Because Russia as a whole is simply too insignificant economically: "Even since the Crimean crisis, German companies have increasingly withdrawn from Russia, direct investments are low and exports from Germany to Russia only make up a very small part of economic output."

He sees the problem in the West's actions that Russia is being treated too timidly: "The West should react to Russia's current policies with far-reaching sanctions. The economic consequences bear no relation to the political ones if other states were to react timidly to them encouraged by sanction to do the same as Russia." He refers to the example of Taiwan: "Should China take over Taiwan by force, that would plunge the world economy into a deep crisis, also because Taiwan has an enormous share of the world market in the manufacture of semiconductors. The restrained sanctions against Russia should undermine China's desire to annex Taiwan don't exactly reduce it."

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