Of all the voices passing judgment on the economic ramifications of Russia’s invasion of Ukraine, the loudest has been the stock market.
It’s probably also the least accurate.
Major stock indexes in the United States and Europe tumbled roughly 6 per cent in the week leading up to Russia’s attacks on its neighbour, and equity markets elsewhere around the world suffered similar slumps. The selling wiped out several trillion U.S. dollars in global market value in the space of a few days.
Commentators pointed to the sell-off as evidence of the economic pain coming from an armed conflict in the heart of Europe. Look, they said – the damage has already begun.
OK, breathe. The stock market is not the same thing as the economy, any more than a bookie’s cellphone is the same thing as a horse race. Markets are prone to melodrama in these moments, as investors try to bulletproof their money from fast-evolving risk, and the opportunistic prey on their fears.
Sell-offs are, routinely, on a grander scale than even the worst-case economic possibilities. There are few, if any, scenarios in which North American gross domestic product plunges by anything close to 6 per cent.
But to the extent that the sell-off was evidence of a new wave of uncertainty, it wasn’t wrong. There are a lot of questions about how a war in central Europe might affect the economic health of Europe and the rest of the world. The markets may have overstated the scale of the risk, but not the sincerity of the fear.
It’s probably safe to say that the economic threats are akin to tossing a stone in a pond: a big splash at the centre, with ripples that diminish in size as they get further and further away. The threat to the Ukrainian economy is pretty obvious, and potentially severe. Russia faces a serious cost of economic sanctions against it by major Western trading partners, never mind the potentially great expense of waging a war (which the country’s predecessor, the Soviet Union, learned the hard way in invading Afghanistan four decades ago). But how big a splash the invasion makes, and how disruptive and far-reaching the ripples, depend on how long and involved this conflict becomes – which is very hard for anyone to predict.
In a research report last week, Toronto-Dominion Bank’s economics team ran two simulations – a “benign” scenario in which the Russian incursion into Ukraine is short-lived and its economic effects fade within a couple of quarters; and a “severe” scenario where the conflict and its economic fallout stretch well into next year.
In the short-war case, TD’s economists estimated the conflict would slice about 0.5 percentage points from the euro area’s economic growth this year; the impact on the United States and Canada would only be 0.1 and 0.2 percentage points, respectively. The longer-war scenario, on the other hand, would wipe out a very serious 2.4 percentage points of growth in Europe, 1.2 percentage points in the U.S. and 1.5 percentage points in Canada.
Now, the direct economic effects on Canada from anything Russia or Ukraine do are pretty inconsequential. The two countries, combined, represent a fraction of 1 per cent of Canadian trade.
The economic threat stems from the risks that the conflict implies for global energy supplies. Russia is the world’s biggest natural gas exporter and its second-biggest oil exporter, and most of that goes to Europe. Should the war, and/or European opposition to it, lead to significant interruptions in shipments, the economic ripples would become serious indeed.
Just the worries over such a possibility have already sent European natural gas prices soaring, and global oil prices to seven-year highs. Many analysts have been quick to frame this as a serious inflationary threat, at a time when Europe and North America are already grappling with multidecades-high inflation. Capital Economics economist William Jackson estimated in a report last week that the higher prices could add as much two percentage points to European inflation rates.
But surely, any substantial and/or sustained cutting of Russian oil and gas supplies would mean a serious slowing of economic activity in the countries reliant on those supplies. Economic slowdowns are disinflationary, not inflationary. In that event, inflation would be the least of Europe’s worries.
“A cessation of energy flows … would cause a recession in Europe,” wrote Montreal-based economic research firm BCA Research in a report last week. A recession in Europe, would, obviously, have serious spillover effects in the rest of the world, including Canada.
Most analysts see that as pretty unlikely. The Russian government depends on revenue from oil and gas exports for more than one-third of its budget. It’s in both Russia’s and the European Union’s best interest to keep the oil and gas flowing, even as the tensions between them over Ukraine intensify.
If that holds, the knee-jerk reaction of stock and commodity markets to the invasion won’t last long, and the economic impact, while not insignificant, will be manageable once you move much beyond those directly involved in the conflict.
Carl Weinberg, chief economist at independent research firm High Frequency Economics, argued in a research note last week that the more enduring threat to Europe’s economic health will come from the spending decisions that the Russian threat forces on the continent. He believes governments, whose budgets are already overstretched by the pandemic, will have to divert funds away from growth-promoting investments in favour of defence spending.
“In short order, look for massive investment in rearming the EU, at the expense of growth in real income per capita,” he said.
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