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International Journal of Management Science and Business Administration

Volume 8, Issue 4, May 2022, Pages 44-52

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Economic Consequences and Implications of the Ukraine-Russia War

DOI: 10.18775/ijmsba.1849-5664-5419.2014.84.1005
URL: https://doi.org/10.18775/ijmsba.1849-5664-5419.2014.84.1005 

¹ Madina Khudaykulova, ² He Yuanqiong, ³ Akmal Khudaykulov

^1,2,3 School of Management, Huazhong University of Science and Technology, China

Abstract: Since the end of the Cold War, the sanctions against Russia have been the harshest and most costly imposed on a major economy. They appear to be unprecedented in terms of speed, breadth, and global coordination. The latest situation heightens the sense of danger that comes with cross-border financial and operational vulnerability. Even if future oil and gas embargoes are imposed, the economy of Russia will rest on its current export strategy, which may be tough to weaken.  The important factors to take into account at the onset of the war are the opportunity cost of military investment, the humanitarian loss of the financial system, and the burden of repairing post-war damage. In this paper we review the economic impact of war, and discuss the potential implications of the Russia Ukraine war on the local and global economies. Overall, there are human costs of war along with the economic influences like building, devastation, inflation, limitation of services debt increase, and daily economic life.

Keywords: Ukraine-Russia war, Economic consequences of war, implications of the Ukraine-Russia war, Reducing energy reliance, Consequences of war

1. Introduction

Historically, military conflicts have had a significant impact on the regional and global economy, ranging from economic, trade and monetary devastation, to loss of production and labor capacity, resources and livelihoods. By extension, not solely are consequences felt by the involved parties, but the spillover is experienced by trading parties and neighboring nations. Geopolitical risks are framed as terror attacks (Plakandaras et al., 2019). Many authors have examined uncertainty and geopolitical risks as the driving forces for commodity prices, emphasizing the relevance such risks bear in the forming of financial and macroeconomic cycles (Antonakakis et al., 2017; Bilgin et al., 2018; Gkillas et al., 2020; Hu et al., 2020; Joëts et al., 2017). Following Russia’s assault on Ukraine on February 24, 2022, the US, Europe, and a number of other countries slapped new economic sanctions on the country. The sanctions have a significant economic impact on the Russian economy. In 2022, Russian GDP is expected to shrink by 12.5 percent to 16.5 percent, impacting manufacturing, demand, and capital. At this point, a few judgments appear to be in order. First, Russia’s strategy of acquiring foreign assets during periods of relative calm in order to fund military activities no longer appears viable. There is now even more reason to question the wisdom of relying on rogue regimes for key energy and raw material supplies. The latest situation heightens the sense of danger that comes with cross-border financial and operational vulnerability. Since the end of the Cold War, the sanctions against Russia have been the harshest and most costly imposed on a major economy. They appear to be unprecedented in terms of speed, breadth, and global coordination. The important factors to take into account at the onset of the war are the opportunity cost of military investment, the humanitarian loss of the financial system, and the burden of repairing post-war damage. In this paper we review the economic impact of war, and discuss the potential implications of the Russia Ukraine war on the local and global economies.

2. Economic Impact of War – Review of Factors

2.1 Macroeconomic Effect Determinants

Reducing energy reliance

Oil and gas imports from Russia to the EU in 2019 were valued at E200 billion each, which amounts to twice the foreign exchange reserves in G7 countries at the end of 2021 (Pisani-Ferry, 2022). An embargo on Russian oil imports drove up prices on the global market, thus inducing the supply shock, consequences of which can be mitigated by engaging in trade with supplementary suppliers. To decrease the reliance on Russian supplies, the EU will have to diversify sourcing, and this encompasses the redesigning of the European energy system, including building networks for tying and diversifying potential smaller energy suppliers.

While oil and coal can be exported without significant infrastructural requirements, trading of gas is infrastructurally dependent, which further hampers the capacity for diversification. Europe’s dependency on Russian imports is significant, and the suspension of gas would cause the EU to lose 40% of its gas supplies. However, due to trade interdependency, Russia stands to lose more if its exports were to be cut off. EU meets only 8.4% of its total demand for energy from Russia and has a greater prospect for sourcing diversification than Russia has for export market diversification. According to some authors, should Europe be depleted of Russian imports, it is speculated that the EU imports from alternative suppliers would have to rise by 70%, which would be extremely expensive in the short run, but the economy would get adjusted and the move would be cost-effective in the long-run (Pisani-Ferry, 2022). One of the greatest advantages of strategic sourcing diversification is attaining autonomy (Loftin, Lynch, and Calhoun, 2011). However, to decrease the existing reliance on Russia, the EU has to either reduce the demand for imports by decreasing the domestic demand, or by way of alternative sourcing, such as closing up nuclear plants and deploying renewable energy.

Demand elasticity

In line with classic economic theory, the macroeconomic effects of the embargo on the imports of Russian energy are determined by the relevance of gas, oil and coal for industrial manufacturing needs and by the elasticity of resource substitution (Bachmann et al., 2022).  Low elasticity is counteracted by resource reallocation as this allows for continuous production. However, the effects of such strategies are not yet fully transparent amidst the Russia-Ukraine conflict due to them being subject to high uncertainty. What is clear from the previous research is that in the short run, there is always a certain level of inflexibility, but this changes with time as production are adjusted to the alternative input substitution independent of Russian energy (Pisani-Ferry, 2022).

Supply shock

For the calculation of the shock magnitude and effect on upstream production, the Baqaee-Farhri model is frequently applied. It is the multi-sector model that allows predictions on the impacts of the disruption across input-output linkages, especially the downstream production with regard to energy input (Baqaee and Farhi, 2021). The conceptual framework conveys the role of production chains when the shock occurs, i.e., the model presumes the occurrence of a ‘production cascade’ and measures its impacts. Furthermore, the Baqaee-Fahri model also deals with international trade and the prospect of substitution.  When the domestic production increases in price post embargo on Russian energy, the alternative channels should be considered. According to the assessment of gains from trade, the nonlinear production networks significantly increase trade gains (Bachmann et al., 2022).

Even prior to the conflict, the EU was already severely damaged by COVID- induced shock posing trade deterioration and rising inflation due to an increase in energy prices. The European Central Bank faced inflationary challenges, which have additionally sharpened due to the Russia-Ukraine conflict as it posed a long-lasting shock. Generally, when the commodity price shock emerges, as is the case in geopolitical threats, the Central bank should deal with indirect secondary effects and avoid counteracting the immediate inflation impacts. Rather, the permanent relative price changes should be accommodated. Measures taken by EU members to mitigate the consequences and lessen the blow from supply shock include transfers and across-the-board tax cuts and price controls. The latter will impact the electricity price index and is likely to be costly. Due to the conflict, interventions are made to revise the drivers of electricity pricing based on the cost of marginal energy sources, which functions as a shock transmitter to gas prices, and eventually leads to an increase in rents for electricity producers. Geopolitical conflict will prompt the changes in the EU policy approaches and lead to governmental market intervention. Accounting for the fiscal support, measures implemented at the beginning of the second half of 2021 included budgetary costs from 0.5% to 1% of GDP, and new measures to address the rise in energy prices can steer the cost to 1 % of GDP (Pisani-Ferry, 2022).

2.2 Industrial Vulnerability

The crisis impacts an already pressured automotive sector because of several scarcity and high product and raw material costs: metals, transistors, cobalt, lithium, magnesium.Major automakers in Western Europe are served by Ukrainian automotive businesses; some have announced manufacturing European factory layoffs, whereas others have planned downtime because of semiconductor constraints.

The airline industry is considered the most vulnerable one, while the airline and maritime freight businesses can be impacted by the higher costs of gasoline.  Almost a third of their total costs are accounted for fuel which is followed by the refusal of Russian airlines access to the borders of European countries like the United States, and Canada which has urged Russia to block their flights from entering its airspace. Airlines will have to travel longer distances which causes higher costs. Therefore, there is limited room for airlines for cost rises because the revenues have been impacted by the pandemic. Freight transportation between Asia and Europe via Russia has been disrupted which limited European companies’ business through Russian railways. The petrochemical feedstock is predicted to become more costly, along with increasing natural gas prices to impact fertilizer markets and the entire food business.

2.3 Consequences of War

Transformation and budgetary impact

Geopolitical risks are recognized by IMF and ECP as a geopolitical factor posing threat to economic welfare (Palakandaras et al., 2018), and the term refers to either tensions or wars among states that have an impact on international relations, and the broader concept further encompasses risks arising from the escalation of such conflicts (Caldara and Iacoviello, 2018). Significant budgetary transformations take place during wars and conflicts, as the budgets now have to be drawn and resources reallocated to alleviate the price impact of major supply shocks, reduce overdependence on resources imported from the high-risk country, for launching the contingency energy resilience agenda and for stronger integration of energy systems. At times of adversity, such as geopolitical risk usually entail, countries are forced to ensure the economic stability, and the investments are made to contain the price consequences of aggravated supply shocks, increase the sourcing capacity, and secure humanitarian aid (Hang et al., 2021).

The costs of wars are frequently underestimated ex-ante, according to Nordhaus (2002). He projected that the net present value of the costs of waging war, rebuilding, and the macroeconomic consequences may vary from $100 billion to $1.9 trillion. Modeling the macroeconomic effects, McKibbin and Stoeckel (2003) concur that the expenses of war would exceed the budgetary outlays. Davis and colleagues (2003). In the study conducted on the population of a thousand investors, three-quarters of the respondents reported that the political uncertainty and diplomatic and military conflicts have a significant economic impact on financial markets (Bouras et al., 2019). Furthermore, defense spending is often increased in an effort to lay down the budget for an effective defense policy. During the current conflict, the EU has increased investments in decarbonization, digitalization, and resilience.

In the current case of the Russia-Ukraine conflict, the expenses of decreasing the reliance on the Russian imports in the short run would amount to €100 billion, of which €50 billion would be invested in rebuilding the reserves, and €25 billion would be an additional cost for other suppliers and €25 billion would go to the coordination of distribution over EU.

A surge in defense expenditures

There has been a lot of talk about the expenses of the Ukrainian conflict. However, the actual direct cost is the opportunity cost of resources used in the competition that cannot be employed elsewhere and the welfare losses of those killed or injured. This cost to the United States comprises not only government resources but also lost productivity of National Guard, and Reserve personnel (hereafter Reserves) mobilized because of the Iraqi venture and unable to execute their civilian duties, as well as the worth of lives lost and injuries. During times of war, we usually see a significant increase in social sector debt. The government is willing to borrow significantly more than usual because of patriotic support for the war effort. The United Kingdom spent thousands of dollars during the First and Second World Wars. In both cases, the national debt grew considerably. Throughout the postwar decades, debt continued to rise as a result of rehabilitation and the development of the welfare state.

In a crisis situation, as a geopolitical threat to safety, governments are bound to intervene either by interfering in markets and posing sanctions on risky countries or by way of providing financial support in response to shortages and resource scarcity, which is a burden to public finances. Securing and amazing reserves have to be publicly financed as private companies are neither willing nor responsible for ensuring the supply due to possible losses they would face during resource price volatility (Pisani-Ferry, 2022). Europe has provided financial support to Ukraine amounting to €500 million worth of military assistance package (Pisani-Ferry, 2022). The geopolitical risk increases the defense expenditure either through implementing a debt fund or through a tax-financed increase in spending. Neighboring states often perceive conflicts as a threat and therefore extend their defense expenditure (Smith, 2014; Collier, 2007), and the action has an effect on their economic growth Zielinski et al., 2017; Murdoch and Sandler, 2004).  With regard to the current Russia-Ukraine conflict, EU member states have from 1.4% to 2% of GDP invested in defense budgets and are likely to increase the expenditure. According to the estimation by Pisani-Ferry (2022), if there will be no direct military actions assumed in the conflict, the investment in European defense efforts could reach €20 billion in 2022, and €40 billion in 2023, respectively.

Inflation

Doubt in the financial system, the high uncertainty, and unexpected decrease in people’s income has been caused by conflictive currency devaluation. To cover the war’s expenditure the Confederacy lived in poverty during the American Civil War. Generating money seemed like a solution for them, but it lead to a dramatic decrease in the value of the currency. The most influenced part of the people is certainly middle-income workers because their investment lost its value.

A nearly empty economy, high amounts of public expenditure, and an unemployment problem made the United States experienced a surge in inflation during WWII. A scarcity of goods and services, as well as increased costs for essential resources such as oil (Interestingly, price controls and rationing were used to keep prices in check during WWII.), lead the economy to face inflation caused by cost-push. Hyperinflation would happen when the country’s manufacturing is highly restricted by the war that is because the government tries to create new money to cover the expenses. A real example can be Hungary and Austria which experienced record inflation in 1946 because of their ruined economy.

Oil prices and war

Increased oil prices are the result of endangering energy supply that is proven by the literal hypotheses which suggest geopolitical risks and threats influence crude oil futures returns. Geopolitical risks acts, and threats have a significant negative impact on the process of determining oil prices, (Antonakakis et al., 2017; Mitsas, Golitsis, and Khodaykulov, 2022). Higher oil prices rose from the Gulf War in 1990, for example. After the invasion, oil prices soared from $21 per barrel in July to $46 in mid-October. (However, prices plummeted quickly.) Oil and gas prices rose as a result of Russia’s invasion of Ukraine in 2022, resulting in increased global gasoline prices, (Pisani-Ferry, 2022). Russia is the main oil and gas producer in the world that the international restrictions have to lead the increase in the price of gas and oil and limit their production.

The monetary cost of war

The damage of war is unavoidable even though it encourages domestic production and use. The important factors to take into serious account are the opportunity cost of military investment, the humanitarian loss of the financial system, and the burden of repairing post-war damage. Another factor may be the type of war, how long it lasts, the place where the war happens, and the way of fighting. The United State had wars during WWII, the Korean War, and the Vietnam War for instance. Domestic demand appeared to be boosted as a result of the wars, with certain manufacturing businesses performing especially well. We must keep in mind, however, that these wars took place in countries such as the United States. Asia and Europe bore the worst of the carnage. Also, see The Cost of War.

The most extended financial expansion has been experienced that explained borrowing was not a progressive factor after WWII (Britain post-World War II). After the Civil War and the First World War, the UK  unconditionally suffered leading the unprecedentedly long unemployment along with the veterans of extremely bleak career prospects. The USA and Europe managed to reach a betterment in the working conditions after WWII. However, there are some countries with a devastated economies after World War I that could not repair war effects like Germany. In 1920 political extremist actions were experienced in Germany along with the wars in the years coming. The same mistake is not repeated by the Allies having had WWII. The financial boom of Europe, especially Germany is due to the support of the USA to them.

 A country’s economic strength can be severely harmed by a war conflict (Hang et al., 2021) The decrease in the lives of people and lover GDP and the damage to the touristic business, personal manufacturing can all be affected by the war. According to the study, a never-ending war and increased weapon availability can lead to a rise in armed violence and criminal enterprises.

Loss-of-GDP

This graph depicts Burundi’s anticipated GDP loss as a result of the civil war. It’s derived from a pre-war GDP trend estimate and actual GDP. It reveals that a century of fighting has resulted in a considerable drop in GDP. However, the graph indicates in the battle a significant portion of GDP is used on degrading military weaponry. Health-care and education offerings are projected to be drastically reduced in the future.

3. Economical Actors – Different levels of Development and Ranking

As promised, the result is immediately visible. The harm to the Russian financial and economic system includes, but is not limited to, a fall in the ruble (down more than 25% against the dollar during last month amid increased volatility) a significant increase in the central bank’s monetary rate, and capital restrictions. Russia experienced unexpected share market closures along with the deletion of RuBonds from global indexes. Additionally, Russian companies involved in the worldwide stock exchange have lost their worth that is followed by the removal of Russian markets from the international base.

Those who have been singled out in the past have typically found ways to mitigate the severity of the penalties. Numerous countries around the world, on the other hand, have continually raised the stakes by increasing and broadening sanctions against Russia. There have been several actions in the form of economic warfare, particularly the restriction of the Russian central bank’s access to foreign assets to increase the value of the Russian monetary system, support the finance, and pay for the invasive damages that resulted in the toughest Russian sanctions.

Financial penalties are one of the most prevalent invasion response methods. The inter-institutional transactions of Russia through the SWIFT system have been excluded, the central bank has been frozen along with several Russian international commercial bank assets. Exportation of technological assets to Russia and the several Russian oligarchs’seizure of international assests are the other examples of limitations.

The Russian economy will be in significant difficulties by 2022, with the country likely to face a long period of recession. Following last year’s comeback, the adjusted GDP forecast for 2022 is -7.5 percent. As a result, the country’s risk rating has been downgraded from B to D (moderately high) (very high) according to statistics. The decline of the Russian currency is followed by the inflation of consumer prices. The reason for the above-mentioned situation is because there are sanctions on major Russian banks, Russian national debt handpicked by Russian elected authorities and millionaires, and export controls on high-value components.

The Western depositary countries imposed a freeze on the Russian banks, as a result, the Russian central bank can not use them and it decreased the impact of the Russian reaction. But the external public depth of Russia is not too high that is because its economy is strong enough to overcome the financial problems along with its consistent bank account deficit and substantial capital inflows (app. USD 640 bn).

The Russian imports have been limited by EU countries but the Russian economy is expected to receive support from Asian energy exports. On the other hand, the Russian industrial, processing, and quarrying sectors will be ruined because of the restricted access to Western-made electronic products, PC, communication, robots, and security technologies based on data.

4. Impacts on the Global Economy

The motor, shipping, and chemistry sectors are especially vulnerable due to lengthy inflation caused by costly commodities which put the economy in danger of deflation and civil turmoil. The betterment of the international economy is put in doubt because of the disruption of financial markets caused by the Russia and Ukraine conflict. Militarized conflicts and wars have been shown to have a huge impact on regional and global economies in the past (Jola-Sanchez and Serpa, 2021; Hang et al., 2021). According to statistics, In 2022, the Russian economy will be in a serious recession of 7.5 percent, lowering Russia’s risk rating to D. (very high). The economies of Europe are the most vulnerable: In 2022, institutions predict at least 1.5 percentage points of further deflation, with GDP growth perhaps slashed by 1%.

The conflict is also causing chaos on the emerging economies of Europe and Central Asia. Due to the pandemic’s lingering impacts, this region is already on the edge of having an economic downturn this year. Apart from Russia and Ukraine, growth expectations have been decreased in all nations due to war-related spillovers, weakening euro-area growth, resource, marketing, and monetary rundowns. Russia buys from many Asian countries so the remittance from Russia to some Middle Asian countries is equal to 30% of GDO such as the Kyrgyz Republic, and Tajikistan. Middle Asia and South Caucasus import nearly 75% of the wheat while Russia and Ukraine import about 40% in the region.

The long-term effects of this cash-based war-fighting weaponry are unknown. While it is difficult to foresee how events will unfold, pre-existing pressures on countries to delay or prevent global integration may become much more intense. Whatever we can say, there is no returning back to a world that prevailed before large economies were sanctioned. When the onslaught began, monetary world markets crashed, sending oil, biogas, steel, and food bills are all skyrocketing. The recovery of the financial situation is being delayed due to the expensive commodities that lead to the continuous rise of inflation followed by unstable societies.

5. Impact on the European Economy

The economic effects and the potential severity of the blow to the European economy arising from the suspension of Russian energy in large depends on resource reallocation, fuel shifting, demand reduction, and substitution of energy sources.  It is predicted that most Russian natural gas reserves in Europe will be unlikely to replicate, and present current prices will have a considerable influence on inflation. Europe is predicted to face difficulties in oil and natural gas consumption because it mostly relies on Russia on them. With the barrel of Brent trading above 125$ and natural gas futures implying prices permanently above 150€/Mwh, estimates at least 1.5 percentage point additional inflation in 2022, which will decrease the household consumption and low GDP to nearly a basic level. The Eurozone’s trade dependency predicts a general decline and Germany, Italy, and most Central and  Eastern European countries are still dependent on the Russian natural gas.

The energy consumption stems from the application of Russian imports in the industry (heating and cooling purposes), households, trade and commerce, power provider purposes, and transport (Bachmann et al., 2022).   Russian gas imports to the EU have significantly decreased since June 2021 and at the beginning of 2022, with the share decreasing from 40% to 20-30% (McWilliams, Sgaravatti and Zachmann, 2022). The EU has witnessed an increase in, the prices of gas, oil and coal before the conflict with Ukraine has spiraled following the release of COVID-19 restrictions, the appreciation of the US dollar, and the OPEC hesitance to increase extraction (Bachmann et al., 2022).

Gas consumption that is used for electricity may be lowered by using lignite and hard coal, and even nuclear energy. Costs savings from the reduction of imports and substituting energy sources can have a significant positive impact on decreasing the financial burden of the European economy provided that the energy generation in industrial power plants also transitions to alternative input applications (Mahler, 2007).  Russian oil imports may be substituted by switching suppliers as there are several additional sources available on the world market.  The overall costs will be determined by the timing of targeted policy measures, i.e., the action should be assumed regardless of the embargo to avoid larger losses during 2022 and 2023.

It is estimated that a complete suspension of Russian natural gas exports to Europe in 2022 would increase costs by 4%, bringing annual GDP growth close to zero, if not negative, depending on demand destruction management. The Russian-Ukraine crisis has sent shockwaves throughout the global economy. As supply disruptions have become more common, demand for commodities prices and significant energy has risen considerably (Bachmann et al., 2022, Chepeliev et al., 2022). Sanctions and trade restrictions have also been imposed on Russian institutions, enterprises, and individuals, (Berner et al., 2022). In conclusion, a common refugee crisis with about four million Ukrainians lead to an increase in economic chaos.

6. Discussion and Implications

Militarized conflicts and wars were previously found to have an immense effect on the regional and global economy (Jola-Sanchez and Serpa, 2021; Hang et al., 2021). Wars and conflict have detrimental consequences not solely for the states involved, but also for those countries that are indirectly impacted by the tension (Hang et al., 2021). Aside from direct costs that are generally measured in terms of lives and resources lost, added costs include destruction of property and damage to international trade (Glick and Talyor, 2010).  For instance, Bogart (1919) estimated that the direct costs of World War 1 amounted to $186 billion in 1913 prices, while Glick and Taylor (2010) found the trade-related costs of World War I were 2.55% of world GDP on a flow basis, which equates to a stock value of $104 billion in 1913 prices. Wars and military conflicts drastically reduce the trade among adversaries via embargos or consumers’ patriotism, however, after the cessation of immediate military threats and no tension predicted in the future, the trade will slowly recover. The current Russia-Ukraine war and the Chinese alliance will dramatically alter the trade of energy, oil, raw supplies and, components and raise the hesitancy of Western consumers (Simchi Levi and Haren, 2022).  The increased imposition of sanctions has impacted the supply significantly (Loh and Tang, 2020). For instance, due to the tensions between the US and China, Chinese global supply chains that were used as the main trade channel for Western consumers are becoming less secure (Pamuk, 2020). Bluszcz and Valente (2019) examined the economic sanctions the EU imposed on Russia in the aftermath of Crimea’s annexation in 2014 and the Donbas war and found that the sanctions had negatively influenced both Russia and the EU due to the indirect effect and interdependency of trading (Bluszcz and Valente, 2019) and cooperative political relations (Kaempfer and Lowenber, 2007). Sanctions have a direct effect on export, but only an indirect effect on GDP, as GDP is more subject to taxation and overall performance (Giumelli, 2017). War always leaves a debt legacy and an army of demobilized warriors (Hang et al., 2021).

7. Conclusion

Some critics think that war may urge the flourishment of the demand, jobs, inventions, and the benefits of commerce. Overall, there are human costs of war along with the economic influences like building, devastation, inflation, limitation of services debt increase, and daily economic life.

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