x Abu Dhabi, UAETuesday 25 July 2017

Economics, not politics, may save us from a new Cold War

Tensions between the West and Russia over Putin's annexation of Crimea should be solved by new financial interconnectedness, writes Alan Philps.

Despite assurances from President Vladimir Putin that he has no intention to seize more territory from Ukraine, European leaders are still braced for a long stand-off with the Kremlin. Not long ago, Mr Putin said that he would not send troops to take over Crimea. But already the peninsula is under full Russian military control and on a path to formal annexation by Russia.

There is no question of a military response from the Nato alliance, even though Mr Putin has torn up the European security system by invading a foreign state on the pretext of protecting a population that was actually under no threat at all.

To those who berate President Barack Obama for weakness, it is worth noting that American presidents have always been prudent in past cases of Kremlin muscle-flexing in Europe. There was no military response from President Eisenhower in 1956 when Soviet troops put down the Hungarian uprising. Nato powers sat on their hands when the “Prague Spring” was rolled back in 1968 by the armies of the USSR and its east European allies.

Historical comparisons with the Cold War era, however, do not tell the full story. When the Soviet Union invaded Afghanistan in 1979, the United States had a clear economic sanction that would hurt the Soviet Union – a ban on sales of US grain, which were needed to make up for the weakness of collectivised farming. This made meat even scarcer for the Soviet consumer. The effect on the western economy was minimal, except for some lost sales by US farmers, who have never been short of government subsidy.

Today the western powers are facing a far tougher choice: the economies of Europe and Russia have become ever more closely entwined as Russia has joined the globalised economy. In political terms, the economies are rather different: liberal market capitalism in the European Union and authoritarian crony capitalism in the east. But they use the same banks and pore over the same dealing terminals.

A “cold war” in a globalised world is thus an unknown quantity. Politics and economics are pulling in different directions, and so far economics has the stronger pull.

Despite clear calls for the 28 members of the European Union to impose economic sanctions, the results have so far been weak. The EU has imposed penalties, including travel bans, on 21 Russian and Ukrainian officials, and more of the same is likely to follow. But nothing is on the table that would really hurt.

Officially, the explanation is that the EU is holding its big guns in reserve for use in case Mr Putin tries to seize the Russian-speaking parts of eastern Ukraine. In practice, no one wants to lose business with Russia or endanger energy supplies.

Europe relies on Russia for a quarter of its gas supplies. In Germany, 300,000 jobs are said to depend on trade with Russia. France is currently supplying Russia with two Mistral-class helicopter assault ships – one named Sevastopol after Russia’s Crimean naval base – in a €1.2 billion (Dh6.9bn) deal. The British financial services industry has a lucrative business in recycling Russian oligarchs’ money.

Mr Putin is a careful tactician and has no doubt discounted the likely western response. He may not be excessively worried by a cooling of financial ties with Europe. One of his key projects is to repatriate an estimated $1 trillion (Dh3.7tn) in capital held abroad, much of it in Europe, by banning politicians and officials from holding offshore financial assets. Such money, according to the Kremlin, should be used for investment in Russia.

Thanks to high oil prices, Russia has gold and foreign currency reserves of close to $500bn. This is an ample cushion to ensure financial stability in the short term. But in the longer term, the major difference with the Cold War era becomes apparent. In communist times, leaders did not have to worry about capital outflows, falling stock markets or the plummeting value of the currency.

Mr Putin does have to worry about these now. His plans to create a Eurasian Union, an economic bloc of like-minded former Soviet states, are at an early stage and may never succeed in rivalling the EU. For the moment he has to engage with the world as it is and play by the rules of the globalised economy. Russia needs to modernise and for that it has to have exposure to European and American finance and business methods. Without those, the best and brightest will leave the country and find jobs abroad.

Mr Putin, like the Europeans, finds himself pulled in opposite directions by politics and economics. To preserve any sense of Russia being a great power, he has to wield a veto over the alliances of the former Soviet countries on Russia’s borders, particularly Belarus, Ukraine and Georgia. Mr Putin has to scare the Nato alliance from offering membership to these countries, as he did in 2008 when he invaded Georgia. Governments in these countries have to be aware that their sovereignty is constrained by their big neighbour.

But these geopolitical aspirations do nothing for the Russian economy. Rather, the political uncertainty saps confidence. Goldman Sachs estimates that capital flight from Russia has doubled since the start of the year, to between $45bn and $50bn, suggesting that the outflow over the whole year could be as much as $130bn. At the same time, economic growth is declining, to as low as 1 per cent this year according to some estimates, severely constraining the government’s ability to raise public sector wages.

The optimistic assessment is that economics will dampen Mr Putin’s geopolitical aspirations and the strength of the western response. The red figures on the bond traders’ screens will avert a new cold war. The opposite view is that the adulation that Mr Putin has received from his Crimean gambit will awaken an appetite for more, given that he can offer the people no economic feel-good factor. Then the European governments will be forced to ignore their business lobbies and come up with a real response.

The writer is a commentator on global affairs

On Twitter: @aphilps