Strengthening your own resilience has become a kind of mantra over the past two years under the impact of the corona pandemic. Nevertheless, measures to increase economic security and to diversify economic relationships were implemented only slowly. Will the turning point in the Russian invasion of Ukraine now provide more speed?
After the Second World War, at least in the western world, a broad international commitment to a relatively open world economy dominated for decades.
Unlike in the more distant past, there have been few arbitrary or politically motivated denials of access to key resources and markets. Instead, policymakers were more concerned with changing supply and demand conditions or occasional sharp price swings.
But Covid-19 meant a turning point. Tensions, frictions and deadlocks in global supply chains eroded confidence in an open global economy during the pandemic. For example, prices and markets were not the key determinants in the distribution of vaccines.
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In addition, countries such as China, the USA, but also Germany, set up high hurdles for foreign technology companies to enter the market in view of increasing geopolitical tensions. This is to protect their own national security.
Economic and financial sanctions have become the preferred foreign policy weapon, as is becoming particularly clear in the Ukraine war. Since Russia’s President Vladimir Putin would probably regard direct military intervention by NATO in Ukraine as a declaration of war, there is no way around this non-military arsenal of weapons.
The United States and European countries, in particular, passed sanctions at an unprecedented speed, which, for example, exclude important Russian banks from the Swift international payment system and freeze the assets of the Russian central bank invested abroad.
The West is not using its most powerful economic weapon
Conversely, Russia’s already teetering economy shows how crucially a country’s economic security depends on broad-based relationships with partner countries – the relationships must be resilient, predictable and reliable.
This poses major challenges, especially for member states of the European Union, which are heavily dependent on Russian gas, oil and coal imports. Russian banks, which primarily handle energy imports, are therefore still part of the Swift mechanism.
That is why the West is not (yet) using what is probably the strongest economic weapon in its arsenal – stopping Russian gas, oil and coal imports – because otherwise it would cause itself considerable damage. Italy’s Prime Minister Mario Draghi recently declared: “The events of these days show that it was unwise not to have diversified our energy sources and suppliers more over the past few decades.” Today in the western world – apart from former Chancellor Gerhard Schröder – probably nobody would do that anymore contradict.
At the moment, European governments simply have to deal with what is coming. Much depends on the further course of the war in Ukraine. Much also about the extent to which China decides to support Russia and thus softens the harshness of Western sanctions against Moscow.
But it should be clear one way or the other: If states want to strengthen their security in an increasingly turbulent world in the long term, they have to diversify their economic relationships and integrate this resilience factor into their foreign policy strategies.
Countries should also diversify their export markets
In terms of energy supplies, Europe could emulate Japan, which is totally dependent on imports of fossil fuels: Japan sources oil from various Middle Eastern countries and buys natural gas, especially LNG, primarily from Australia, Malaysia, Qatar, and Russia the USA.
If Europe’s energy procurement had followed the Japanese example more closely, the cost-benefit structure of its sanctions against Russia would be very different. Europe would then have much more power to rapidly drain the funding sources of Putin’s war against Ukraine.
Incidentally, the value of diversification increases with the level of risk one is exposed to. Critics may argue that such diversification is expensive because it reduces efficiency. However, this objection would only apply in a stable, low-risk environment. But such an environment no longer exists, at least since Putin’s attack on Ukraine. Therefore, the costs of diversification are hardly significant. Diversification is the best strategy in today’s world.
And this does not only apply to imports. Given the fact that states can be cut off from markets in a jiffy – China experienced this first-hand during the administration of US President Donald Trump – they should also make efforts to diversify their export markets – albeit a partial diversion from such large economies as the USA or China may seem difficult at first.
The important role of state regulatory policy
The most important thing, of course, is to reduce its dependence on particularly unpredictable trading partners. Countries with which the handling rules are clearly agreed and are likely to remain stable also represent a significantly lower risk, which reduces the benefits of diversification. Still, states should avoid over-reliance on any partner, no matter how stable, if only because of the risks posed by the climate crisis.
Of course, raising the necessary degree of diversification to a level that strengthens a country’s economic security and its negotiating position in the event of a crisis can never be left to the mechanism of supply and demand alone. Naive ideas that have often been contradicted by reality, such as: “The market is always right” do not help here. This is because the economic and strategic advantages of diversification do not fully benefit market participants.
Although market players are aware of geopolitical risks, for example, and for that reason alone they will not refuse in principle to diversify supply sources, for example, they will probably not go far enough in doing so. Therefore, government governance and international coordination have an important role to play in accelerating the diversification process. Given the current threat of Russia’s war in Eastern Europe, politicians have a strong incentive to take the necessary steps. They are long overdue.
More: Supply chains to Russia collapse.