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Ukraine crisis: the economists’ view

Author: ICAEW Insights

Published: 16 Mar 2022

Four economists give their views on the conflict in Ukraine, Russian sanctions, and how the world’s economy will be affected in the longer term.

Russia will be isolated, and inflation is here to stay

George Lagarias, Chief Economist, Mazars Wealth Management 

I don’t think the sanctions will diminish Putin’s resolve over the short term in Ukraine or over the medium term. But what they will do, intended or not, is take Russia back to the Soviet era. 

They will create huge problems in the global supply chain, they’re going to exacerbate inflation, which is currently a big issue, and the central banks will not be able to provide a safety net and mitigate the volatility. I cannot say with any degree of certainty that they’re going to achieve anything other than a more isolated Russia.

In the last few years, we’ve seen a momentum towards deglobalisation. We have a bunch of people in power around the world who belong to an older era. They’re trying to bring the world back to a manageable state from their perspective. 

For an ageing demographic, this is very appealing: “We need to go back to when the world made sense.” But if history teaches us anything, it’s that steps backward never go well. 

The EU is going to suffer the most from the new sanctions because it’s dependent on Russian gas, and it’s close to Russia. The UK may suffer less, but its main trading bloc is Europe, so whatever Europe faces, the UK will probably face equal pressures. The US is better positioned because of geography and the almighty US dollar. It was already on a better economic growth path when this whole thing began. 

Gas prices have suddenly become more important

David Smith, Economics Editor, Sunday Times

This is a battery of sanctions of the kind we haven’t seen before. There are two aspects to it: one is the government-imposed sanctions, and the other is the private sector response to it. That is probably as important as cutting Russia off from the SWIFT system of transactions. 

The Russian economy was not strong anyway. It’s very, very energy dependent, it’s quite a small economy given its geopolitical importance, and this will drive Russia into a serious recession. We’re moving to a situation where Russia is even more isolated from the West than it was when it was the Soviet Union.

There will be an impact on the banking system and the financial system in the West as a result of this. You hope that it is much more robust than it was in the run up to the financial crisis. I think it probably is. 

The other, bigger effect is on the balance between inflation and economic growth. We will see much higher inflation than we were expecting, which was high inflation anyway. Now we’re looking for a higher peak, which will last longer, and that will have more of a depressing impact on economic growth.

For the first time in my professional life, I’ve been looking at the gas price. We thought the April energy price cap of 54% was going to be the worst of it, but it may get worse still. We don’t know what the resolution of the war in Ukraine is going to be. But at the moment, this is all looking quite scary, I think, in terms of an even bigger hit to real incomes. 

Our best-case scenario is that things don’t get worse

Elliot Hentov, Head of Global Macro Policy Research, State Street

For all the potential spillover effects, we are slightly more optimistic that the conflict will remain contained both in military terms and the wider economic and financial impact. 

We do see issues from the price shock in commodities, particularly in energy, food and agriculture. We also see the impact on supply chain stress in a variety of areas. Together, those are going to knock off growth in the developed world by roughly half a percentage point compared to our forecasts before the war. And they are going to raise inflation for this year – 1.5% in the US and 2.5% in Europe. 

Although our base case is somewhat optimistic, it basically assumes nothing gets worse. We’re in a rare situation where our base case doesn’t have an upside, so it can only get worse, if we’re wrong. And it could be wrong by a lot.

The biggest worry from a macroeconomic point of view is that you get a direct supply outage. It’s currently not an issue of gas supply, it’s an issue of price. But if you get an issue of supply, you’re talking about a potential stagflation scenario where large parts of the globe get tilted into negative growth while inflation continues upwards. But we’re far away from that. 

The markets don’t need the end of the war, you need the markets to be able to price out a narrow range of end games. That’s enough for the market to find its footing, reprice and move on. That’s not possible right now. Whatever prices you’re seeing right now are wrong. If there’s severe escalation down the road, things have to go differently. 

Business is intertwined with politics – and politics has changed

Joe Zammit-Lucia, founder of cross-party think tank Radix, author, The New Political Capitalism

For a business to claim, as some do, that it is apolitical, is abject nonsense – always has been, always will be. Business and politics are intimately intertwined in very complex and dynamic ways that never have an equilibrium. They change over time, depending on the circumstances. 

If you go back to the 80s, and 90s, the window of the battle of political ideas was actually very narrow. We had come to the conclusion that Western liberal democracy, free markets and laissez-faire neoliberalism – the Washington Consensus – had won the day. Some people argue, for instance, that Blairism was continuity Thatcherism with a bigger smile. 

That has changed dramatically. The battle of political ideas has widened. I mean, who would have said, If I told you in the mid-90s that the world’s second largest economy by 2022 would be an authoritarian state, people would have laughed. 

Now that the window of political ideas has been blown wide open again, businesses are going to have to learn how to deal with it. They can’t absolve themselves from that. The Ukraine conflict is a rude slap in the face of that process, but it’s part of a continuum. 

The reason that capitalism as a system has survived is because of its ability to change. So we should welcome the fact that it’s changing. If it were rigid like, for instance, communism in the Soviet Union, it would fall apart.

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