Perhaps, not since WWII and then the 1970s, has the world had to deal with the economic effects of a war such as the current one on in Ukraine against Russia. The 8-year war between Iran and Iraq in the 1980s, and later wars in the Islamic world too had their biggest impact on oil prices, which was enough to derail growth in several economies.
But this war is different. It is different even from the recent wars that the US and its NATO allies fought in Iraq and Afghanistan, not too long ago. For one thing, it is taking place between the world’s third largest producer of oil and gas, Russia, and Ukraine. Both happen to also be the bread baskets of the world, providing for 30% of the world’s wheat and 60-70% of the global supply of sunflower oil. Between them, they are also significant producers and exporters of several metals. This war will exacerbate the inflation in commodities and supply shortages that the world was already experiencing during the Covid-19 pandemic.
It is a manifestation of how globalized and interconnected our economies are today. Governments need to be prepared for various shocks that this war can cause across several commodities and their prices, which will put many products out of the reach of most people. As The Economist warns in this article, severe fuel and food shortages can cause civil unrest and riots in many countries around the world.
Not just that. Thanks to stringent and swingeing sanctions imposed by the US and its Western allies, it will be near impossible for Russia to trade in most goods with most of the world. Therefore, the shortages and price spikes are not likely to be brief, but long-lasting, as long as the war itself and Russia’s hostile behaviour and rhetoric.
Therefore, the world needs to find ways to diversify their import requirements away from Russia and Ukraine. Europe, the region most dependent on Russian energy, has just concluded a summit on diversifying its imports away from Russia. The first and most natural instinct of many governments will be to resort to protectionism. Already with the chip shortage that the world was experiencing thanks to the pandemic, we had leaders in many countries say lets bring back production, instead of depending on other countries.
But that’s exactly the kind of response that the world does not need. In certain product categories and industries where we know the long-term needs and potential for growth are huge, such as semiconductors, more countries need to produce them, in order to supply the world. So, it’s not “let’s make it here for ourselves”, it’s “let’s make more of it for us and everyone else” that will prove more helpful. The global supply chain in electronics is too vast, interconnected and complex for countries to start raising protectionist barriers. As it is, world trade is likely to slow down again just when it had begun to resume growth after the pandemic. Therefore, we need more countries to step in to fill the shortfall created by the war and keep trade open and flowing.
Besides countries needing to find other sources of imports to meet their requirements, they also need to keep a check on prices. Governments around the world were already facing high inflation in fuel, food and most other goods and services and some have started addressing the problem, already. Where the signs of a wage-price spiral are already evident, such as the US and UK, their central banks have not only tapered the bond-buying programme, but also started raising interest rates.
This will be a big requirement from governments in developing countries, where inflation is likely to hit the poor the hardest. Inflation, especially of fuel and food, affect the poor most adversely, and therefore, governments must have plans for mitigating the effects on the poor, through subsidising food purchases, free distribution of foodgrains (like in India), collaborating and contributing to the World Food Programme, etc. I remember reading in The Economic Times here in India over a decade ago, about India getting a chance to export wheat in a substantial way when the crop in Ukraine and Russia had failed that year due to bad weather. Similarly, countries need to do their bit to make up for the shortfall now and earn income as well.
Inflation and supply shortages of most other commodities from metals to fertilisers and chemicals to oil will also impact production and crimp demand. Economies therefore, are likely to see a slowdown in manufacturing and weakening consumer demand over time. Services, which were the worst impacted during two years of the pandemic are starting to come back, but soaring oil prices will mean exorbitant air fares and that is likely to once again dampen travel and hospitality industries. Other services such as information technology, financial services, telecom, retail and the like will do reasonably alright under the circumstances. Construction is likely to be dampened as commodity prices stay high.
This means that governments will have to step in and spend to grow their economies. Hopefully, that will not just be in physical infrastructure, since commodity prices will be prohibitive for a while, but in social infrastructure. Certain services such as education and healthcare offer scope for greater investment and growth. After two years of the Covid-19 pandemic, which have already had the most terrible effects on education, and have also exposed the weaknesses of our healthcare systems, it is time to invest wisely in them. Governments would do well to prioritise spending in these areas, with the aim of building capacity for the long-term.
The fourth high priority area for governments would be to watch out vigilantly for the next wave of the pandemic or possibly a new variant. They ought to plan for booster vaccinations, better testing and localized lockdowns in containment areas, while avoiding large scale lockdowns. What’s more, vaccines and vaccination infrastructure are still required in most parts of Africa and the world should stay focused on enabling this. Multilateral organisations such as IMF and the World Bank, ADB and others ought to continue to find ways to ease the debt burden on the most stricken economies, allowing them more time and better terms to make their repayments.
In countries with already high unemployment, governments should stay focused on creating good quality jobs both in the public and private sectors. However, in a situation where high inflation can crimp demand, and there is excess capacity in the system, private investment might be hard to come by. Governments can look at encouraging MSMEs in investing in new areas of growth and importance such as clean energy, healthcare, digital payments, AI and robotics, etc.
And finally, governments in the West need to focus on helping Ukraine as well as keeping the dialogue going with Russia, in order to find an end to the hostilities and the devastation. They are most immediately confronted with the exodus of Ukrainians fleeing the war, and these refugees must be settled in as many countries as possible. As usually happens with most conflicts and wars, refugees hardly ever return to their home country, so a long-term viable plan needs to be worked out for their future.
We need to find an end to the war. But we also need to seriously consider its economic impact which, in a globalized world economy, is going to be felt everywhere. Governments need to do their part by focusing on the economically most vulnerable.
The animated owl gif that forms the featured image and title of the Owleye column is by animatedimages.org and I am thankful to them.