Russia Energy Ban Myth Buster

Frequent arguments against taking action now, and why they don’t stack up -- by @lukaszrachel

Original version: https://t.co/L26ZGfX9IK

MYTH #1: We are not financing Putin’s war (b/c of sanctions, he cannot use the billions of euros/dollars we send him anyway)

FALSE: there’s no doubt that a ban would drastically limit the real resources available for war. Existing sanctions are inherently leaky. They limit the availability of the stock of Russia’s reserves, but the flow of energy revenues on the order of 700 million euros per day is more than enough to hire mercenaries, buy weapons and destabilize EU politics. Over 40% of Putin’s budget revenues derive from energy exports - without this income, enormous cuts to public spending across the board will be required. Printing rubles does not help: without the backing of the real resources obtained through energy exports, the empty rubles would fuel (hyper)inflation and an economic collapse. Currently, forex revenues are sold to support the ruble (which has appreciated most recently), limiting the impact domestically. So yes, there is no escaping it: our energy purchases are directly funding Putin’s war machine. See numbers here and more analysis here and here. See also top Russian economists – the most informed voices on these issues on the planet -- forcefully argue that the energy ban is our best chance to stop the war early (in German here).

MYTH #2: Russia can sell oil & gas to China and elsewhere, so we’d only be hurting ourselves.

FALSE: a complete substitution towards China is infeasible given the scale of European imports: we buy 49% of Russian oil and 74% of Russian gas. And if China becomes nearly the sole buyer, it will bargain hard, limiting the revenue flows. Ultimately, if Putin did not need our money, he would have turned off the tap already.

MYTH #3: Russia would circumvent the sanctions by selling via third parties.

FALSE: secondary sanctions may be employed (Iran provides a recent example). We are already seeing private businesses staying away from Russia in fear of breaching sanctions (e.g. see here)

MYTH #4: A ban would cause “mass poverty” in Europe / would have “incalculable” or “unimaginable” impact.

FALSE: Available estimates suggest the impact could be between 0.5-3.5% of GDP, or 200 to 1200 euros per head in Germany, the country most dependent on Russian energy. It would be less elsewhere. These are significant costs, but they are a far cry from anything that justifies the kind fear-invoking language. State-of-the-art macroeconomic analysis which includes (a) worst case scenarios; (b) impact of cascading effects through supply chains; (c) impact on inflation; (d) parameter uncertainty; (e) demand effects estimates the hit to German GDP between 0.5-3% (middle of this range much more likely than the top). Goldman Sachs assume little adjustment takes place and estimate a loss of 3.5%. The ECB calculates a 1.4% hit to euro area GDP in the most severe scenario of energy ban. Bruegel describe how Europe can do without oil and coal and without gas from Russia. For a longer-term perspective on what a hit to GDP of this magnitude means (it is significantly less severe than Covid, for example), see here.

MYTH #5: The less well-off would be hurt the most, b/c of unemployment and higher inflation. Particular regions and industries would collapse.

INCOMPLETE: the consequences are indeed likely to be uneven, both across the income distribution and also (primarily) across sectors and regions. For example, steel and chemical industries are likely to be significantly affected. Critically, our governments have the appropriate policy tools to deal with these impacts, and given the manageable aggregate impact, they can afford to do so. We know how to cushion the impact on unemployment and incomes of individuals – we have done this before (Kurzarbeit), not least during Covid (which was a much bigger shock, and when unemployment rate didn’t budge, see here). We could also directly protect the businesses that are most affected for example through funding any short-term production stoppages. Some assert that manufacturing is more difficult to assist than services, but this is not true. With a 2% hit to GDP, a deficit-financed support designed to prevent any second-round effects would raise debt-GDP by roughly 2 percentage points (from 71 to 73% in the case of Germany). Time to use this cushion is surely now. A detailed discussion of the distributional issues is here.

MYTH #6: Business leaders and industry experts say it’s impossible to adjust. Don’t they know best?

NOT NECESSARILY: the marvel of market economy is its adaptability. New sources of supply will come on stream and demand will adjust. Production processes will change over time. Only a small degree of substitutability makes a world of difference. There are plenty of real-world examples of how production adjusts, often in extreme circumstances, see here, here, here, here and here (did you know that Nutella was invented as a result of Napoleon blocking cocoa supplies?). Some firms may face short-term interruptions, others may not adjust and will be replaced by new, more flexible firms. This change is costly for the incumbents, so it is not very surprising that it is resisted. See here for more.