Dr. Robin Dhakal
The recent conflict in Eastern Europe between Russia and Ukraine has tested many international norms, institutions, and systems. The strengths and relevance of international alliances, such as the United Nations (UN) and the North Atlantic Treaty Organization (NATO), have been directly challenged by this conflict. Even though the West has been reluctant to make this conflict a direct conflict between Russia and NATO, many countries have applied crippling economic sanctions against Russian oligarchs, government officials, and the Russian economy at large. Most recently, the Biden-Harris administration announced that the U.S. will stop importing oil from Russia. With these unprecedented international economic pressures on Russia, an obvious question arises- what will be the impact on the U.S. and the global economy?
While any war is undesirable, from the global economic perspective, the timing of this conflict couldn’t be worse. We just went through the worst pandemic in recent history and our economy has been recovering from a pandemic-induced recession followed by a high level of unemployment. While the U.S. is not in a direct conflict with Russia, we should expect the Ukraine-Russia conflict to impact the U.S. economy and to influence its monetary and fiscal policies.
It is helpful to know a few key statistics prior to a discussion about the economic impact of this conflict. First, the Russian Federation has a gross domestic product (GDP) of about $4.32 trillion (PPP, 2021 estimates), which is just 1.3% of the global economy, according to the World Bank. However, Russia’s exports make up one quarter of its GDP. There is thus reason to believe that the targeted economic sanctions imposed by the West could have a significant impact on the Russian economy. In 2021, the U.S. imported $30.76 billion worth of goods from Russia, according to the UN Comtrade Database. Oil and oil refinery products amount to sixty percent of U.S. imports from Russia. Hence, the recent announcement that the U.S. is banning imports of Russian oil will surely impact the Russian economy. However, despite the sanctions from the West, Russia’s economy is not likely to collapse thanks to its largest trading partner- China. In 2020, Russia’s exports to China amounted to $50 billion, of which 15% were oil and gas (an amount that is expected to grow during and following the Ukraine conflict). It is also important to note that two of the largest trading partners for China are the U.S. and the European Union. Therefore, it seems unlikely that China would jeopardize its own economy in order to help Russia by exclusively aligning itself with Russia.
So, what does all of this mean for the U.S. economy?
Most of the impact that this conflict will have on the U.S. and global economy will be seen in subsequent supply chain disruptions. The sanctions and economic restrictions placed on Russia mean that we are creating a virtual wall around Russia. Companies are now unable to use Russian airspace or Russian ports to transport goods. This means that it costs companies more money to transport their goods over longer air and sea routes. This is especially true when it comes to the flow of goods between China and Europe. Most of the Russian ports are closed to cargo ships which means companies must find alternative shipping routes. Because of this, since the start of the conflict, other ports around the world, including the seaports in California, have seen increased traffic. In addition, because Chinese warehouses and ports are still not functioning at full capacity because of COVID and its new wave of infections, the supply chain has been further disrupted. Furthermore, the rising oil and fuel prices have made the transportation of goods even more expensive. All of this is bad news for the world, especially since the global economy grew 2.5 times larger over the past 30 years because of ocean transportation, according to a report by the World Bank.
Perhaps the sector hardest hit by the supply chain disruption is the auto industry. Many auto manufacturers have stopped production in Russia. For example, Nissan halted production at its factory in St. Petersburg, and Renault suspended its operation in Moscow. In addition, auto manufacturers rely on many auto parts from Russia and Ukraine. This means that the auto producers are having a harder time finding chips and other parts. For example, Audi halted production for weeks because of the shortage of parts after the start of the invasion. Ford’s plant in Germany reported a similar disruption because of the shortage of parts.
In addition, we are also expected to see an impact in the global food market. Russia and Ukraine combined produce over 30% of wheat and 15% of corn in the world. Because of the conflict and the subsequent sanctions and supply chain disruption, most of the stores of wheat and corn are not expected to hit the global market. Those two products are also essential ingredients in a variety of food products we consume, such as bread, pasta, cereals, sweeteners, etc.
All of this means that we should expect to see shortages and possibly even higher inflation in the U.S.
There are a few economic scenarios that are worth analyzing if the conflict does not end soon. First, the combination of higher energy prices and supply chain disruptions means that the economy experiences a negative supply shock, which may result in stagflation. Although there is no concrete evidence of stagflation occurring in the U.S. economy yet, it remains a possibility if this conflict continues. Because there are no easy solutions to stagflation, the Fed and Congress must navigate the usage of policies carefully, such that we do not enter a bigger recession while trying to tackle inflation.
A second scenario is even more plausible: the conflict increases inflation and affects some specific industries, but the U.S. GDP and unemployment are healthy. This is a relatively easier scenario for the Fed and Congress to tackle. With appropriate policy tools, the Fed can try to decrease the money supply to dampen the fast-economic growth in the hopes of slowing down inflation. In fact, on March 16th, the Fed approved the first interest rate hike in over three years. Even though this is a step in the right direction, the Fed has to navigate these tricky waters carefully, because the Federal Reserve Bank of Philadelphia recently released a revised estimate of the GDP growth rate for the U.S. economy, taking it down from 2.1% to 1.8%.
In either of these scenarios, Congress can aid the Fed by passing appropriate fiscal policy bills that are not likely to increase inflation. Slowing down some discretionary spending like the general government, defense, and foreign aid expenditures would lower government expenditures which will ease inflationary pressure. In addition, reducing targeted tax credits in energy and housing sector and reducing subsidies on fossil fuel industry could help address inflation. However, these steps need to be taken with caution and in conjunction with the Federal Reserve System.
|Dr. Robin Dhakal|
“Dr. Robin Dhakal is an Assistant Professor in the Forbes School of Business and Technology. He earned a M.A. and a Ph.D. in Economics from University of South Florida and a B.A. in Business/Economics and Mathematics/Computer Science from Warren Wilson College. His academic research focuses on development economics and political economy. He has been teaching Economics in colleges and universities for the past nine years. “
GDP, PPP (current international $) - Russian Federation | Data. (n.d.). Data.Worldbank.Org. https://data.worldbank.org/indicator/NY.GDP.MKTP.PP.CD?locations=RU
Reuters. (2022, March 1). Factbox: China-Russia trade has surged as countries grow closer. https://www.reuters.com/markets/europe/china-russia-trade-has-surged-countries-grow-closer-2022-03-01/
Trading Economics. (n.d.). Russia Exports to China - 2022 Data 2023 Forecast 1996–2020 Historical. https://tradingeconomics.com/russia/exports/china
United States Trade Representative. (n.d.). Russia. https://ustr.gov/countries-regions/europe-middle-east