Can Europe afford a Russia trade war?

BRUSSELS - “We’ve known for more than 100 years that protectionism and trade barriers are very bad for your economy”.

So says Hosuk Lee-Makiyama, a trade lawyer and director of the European Centre for International Political Economy, a Brussels-based think tank. The evidence backs him up.

But such considerations did not stop Brussels from effectively waging a trade war on Russia this month - its ban on bond sales to some Russian banks and on sales of high-end technology to Russian oil firms swiftly leading Moscow to imposing a ban on imports of EU food.

Since then, however, support for the EU’s stand is starting to fray at the edges as national leaders start to count the costs.

Hungarian prime minister Viktor Orban and his Slovakian counterpart Robert Fico have publicly criticised the EU sanctions. Orban remarked that the sanctions “cause more harm to us than the Russians”, before adding in typically strident fashion that “in politics, this is called shooting oneself in the foot”.

For its part, Poland has made a formal request that the EU take Russia before the Swiss-based World Trade Organisation (WTO) to overturn the food ban, while a number of governments are already working out how much compensation they will claim from Brussels for their farmers.

The question is whether Europe can actually afford to fight a trade war with Russia?

Lee-Makiyama says that “mutually assured destruction”, at least in economic terms, will be the result of the sanctions and that neither side can afford the measures to last more than six to nine months.

It is still difficult to make anything more than an educated guess at the economic effect of the confrontation, while EU officials stress that its farmers may be able to replace the lost market in Russia with buyers elsewhere,

But there is increasing evidence that the sanctions battle will cause a sizeable dent in Europe’s collective wallet.

Research published on Wednesday (20 August) by Benelux bank ING forecasts that the import ban could cost the EU €6.7 billion, wiping out 6 percent of the EU’s production and 0.04 percent of its GDP.

For its part, ING remarked that its calculations were “a conservative estimate of the economic damage that can be caused by the crisis in Ukraine.”

The uncertainty has clearly dampened confidence, particularly in Germany, whose export-led economy is most reliant on trade with Russia.

The ZEW think tank’s index of financial market confidence in Germany’s economy fell to its lowest level since December 2012 this month. It remarked that the collapse in confidence was “likely connected to the ongoing geopolitical tensions in the Ukraine and elsewhere”.

The same week, Eurostat revealed that the eurozone economy was already flat between April and June, before the sanctions, leading to the bloc’s growth forecasts for 2014 being cut to 1 percent.

Carsten Brzeski, an economist with ING, told EUobserver that, ultimately, the ban “could shave off some 0.2 percentage points from Eurozone growth”. He added that it is “very hard to take into account whether there are any negative spill-over effects or positive off-setting factors like more demand from other countries or repatriation of foreign investments”.

In the pre-financial crisis years, losing 0.2 percent would have been the economic equivalent of a wasp or jellyfish sting - painful, but not for long. But with the eurozone economy flat-lining it could prove to be the difference between meagre growth and a triple dip recession - of high importance politically and psychologically to the bloc.

ING also estimates that the ban could jeopardise 130,000 jobs at a time when the EU is struggling to reduce a high unemployment rate.

While the US, Canada, Norway, and Australia are also subject to identical Russian bans, their trade with Russia is a fraction of the €270 billion in goods and services which were traded between Russia and the EU in 2012.

With the EU already in relative decline compared to the US and China, not to mention emerging economies, it can ill-afford to carry another economic millstone.

But if the EU’s sluggish economy is ill-prepared for a prolonged trade war, Russia is in even weaker shape to cope.

Since the start of the year foreign investors have withdrawn around €60 billion from Russia. Meanwhile, its economy, which grew by 1.3 percent last year, is heading back into stagnation, forecast to grow by less than 0.5 percent in 2014.

Agriculture minister Nikolai Fyodorov told national television on Wednesday (August 20) that the ban would cost “hundreds of billions of rubles” in extra farming subsidies.

While not catastrophic, these snap-shots make it clear that the West’s sanctions are hurting Moscow and will continue to do so.

But for the moment, diplomacy trumps short-term economic interests.

The threats of a Russian invasion of Ukraine remain high. This factor, coupled with Russian leader Vladimir Putin’s continued support for pro-Moscow rebels in Ukraine, despite their being implicated in shooting down Malaysian airlines flight MH17, left the West with little alternative other than to step up its sanctions regime.

In the words of Lithuanian foreign minister Linas Linkevicius, whose country shares a border with Russia: “Better shoot yourself in the foot, than let yourself be shot in the head”.