By Michael Hicks | Ball State University
An immediate question facing Americans today is the economic effect of war in Ukraine. As I write, it is not clear how the Russian invasion of Ukraine will proceed. However, it is impossible not to see echoes of Hitler’s occupation of the Sudetenland in the late 1930s or Saddam Hussein’s 1990 invasion of Kuwait. The primary difference appears to be the willingness of much of the developed world to actively oppose autocratic nations invading democracies. This makes the 1990 experience more salient to understanding the likely economic effects of this war.
The choice of what economic or military sanctions to pursue is largely dictated by the practicality of armed intervention, and the belief that failure to act will lead to worse outcomes. Both NATO and the European Union members have concluded that significant sanctions are in order. This reflects a reasonable belief that Putin has far larger territorial interests than Ukraine and, if left unmolested, will pursue them.
Whether or not the United States takes direct economic action, Americans will face some economic effects of a war in Ukraine. We cannot avoid some pain from Putin’s aggression. Our choice is only how to direct the economic consequences so that it has the maximal effect on Russia, while minimizing damage to ourselves and our allies. That choice necessarily involves targeted economic sanctions.
Thus far, the United States, NATO and European Union nations announced sanctions consisting of two major parts. The first of these targets financial transactions for individual members of the Putin regime, their families and businesses. This is important because it places personal pressure on those who are directly involved in the invasion of Ukraine. Doubtless they have personal assets in Russia, but this would prevent them from accessing funds in banks across the developed world.
Modern banking and intelligence permits these sort of asset seizures, which can be used to compensate Ukrainians who are financially damaged by the invasion. It means the family members of the Putin regime who are in college or working overseas will see themselves cut off from support. This sort of sanction is new, so is hard to fully assess how effective it will be.
The second immediate sanction was Germany’s refusal to certify a second major natural gas pipeline, Nord Stream 2, from Russia. Russia has used its considerable oil and natural gas reserves to cause more volatile energy prices over the past several years. This is likely designed to make sanctions more politically difficult for western democracies. However, the German government, which will be most economically affected by these sanctions, made a clear statement.
Foreign Minister Analena Baerbock said, “For us as German government, it was important to show that for a free and democratic Ukraine, we are willing to also accept consequences for our national economy. Peace and freedom in Europe don’t have a price tag.” I would disagree slightly; there is a price tag to peace and freedom, but it is far lower than that of the broader war she is trying to prevent.
These first sanctions are only the beginning. Should the invasion continue or move westward, Putin faces restrictions on international banking transactions, as well as targeted import/export controls and travel. We have the capacity to place much more severe hardship on Russia. Its ability to withstand severe economic sanctions for long is doubtful.
Russia is a poor country. It has 144 million people, but an economy that is now only slightly larger than Florida. Since 2013, Russia’s economy has shrunk by 35%, which constitute Great Depression-level economic declines for close to a decade. Putin invades Ukraine in part to deflect criticism of its government for a failing economy.
In 2021, per capita GDP in Russia was a little over $10,000 per person, which is below the U.S. poverty line. In fact, after adjusting for inflation, the Russian standard of living is today below that of the United States in 1940. Putin’s frustration at being perceived as leader of a small, decrepit and failing nation is wholly understandable. It is all that and worse.
Russia’s armed forces are powerful only because they have nuclear capacity and are surrounded by weaker nations. It is worth noting that on March 2, 1991, one U.S. Army division destroyed the equivalent of 10% of Russia’s current force of main battle tanks in perhaps two hours. That was an elite Russian-trained Iraqi unit whose radio operators spoke Russian during the battle.
In a fight between the Russian Army and the Texas National Guard, I’d bet heavily on the Texans.
Not only are Russia’s tank numbers modest, its most modern equipment is of the same vintage that Saddam used in 1990-91. This is not tactically important; Russia can beat Ukraine in a war. However, the weakness of Russia’s conventional forces makes it more, not less, susceptible to sanctions. Many of the tanks massed along the Ukrainian border were manufactured in the early 1970s by Soviet factories.
Neither our choice of sanctions or Russian weakness will ultimately insulate us from economic fallout. Our stock indices are down substantially over the past two weeks. While this is likely transient, it is unsurprising that investors would react to the risks of war. Over the past 30 days, the price of West Texas Crude Oil has risen by more than 10%. That is unwelcome, of course, but in the two months after the invasion of Kuwait, the price of oil doubled. That jump seems unlikely today, with strong U.S. energy production.
Also, we do not know if this conflict will also extend into cyberspace in ways that affect the U.S. economy. Clearly, Russia would wish to interrupt our commerce and civic life through cyber warfare. This could be very costly and inconvenient to Americans. However, we possess far more extensive cyber warfare tools than does Russia. They know that, so a broad coordinated attack on the U.S. should be viewed as an act of desperation.
Americans are fortunate to possess great economic power born from our unique liberty and relative peace. It is well that we should use that power to help preserve peace on distant shores. If history provides one lesson on this, stopping tyrants is less costly done early on, when the bill is measured in dollars, not lives.
Michael J. Hicks, PhD, is the director of the Center for Business and Economic Research and the George and Frances Ball distinguished professor of economics in the Miller College of Business at Ball State University.