The bill would enable the government to override parts of the Protocol. In particular, it would end or reduce customs and regulatory checks relating to goods moving from Great Britain to Northern Ireland, and remove EU constraints on tax and subsidy policy in Northern Ireland. It would also end the jurisdiction of the European Court of Justice.

A few days after the bill was introduced, the EU retaliated by beginning legal proceedings against the UK government. But the Westminster legislation is subject to considerable uncertainty: how quickly will it proceed and how far will it be amended in both Houses of Parliament? Whoever ends up replacing Boris Johnson as Conservative leader and prime minister could also influence the future of the agreement.

It is possible that there is some bluff and brinkmanship in the current proposals. The UK government would prefer not to act unilaterally but hopes that the threat of legislation will push the EU to make further concessions while enticing the Democratic Unionist Party (DUP), one of the big political parties in Northern Ireland, to permit the re-establishment of devolved government.

Given a backlog of cases, it may be at least a year before the European Court of Justice considers the alleged infringements of the Protocol. The EU may in fact welcome this delay. For the time being, it can engage in rhetorical threats such as ending the Trade and Cooperation Agreement with the UK that governs post-Brexit economic relations or removing Northern Ireland’s privileged access to the single market.

For at least a year, the UK government has argued that the Protocol contributes to both political instability in Northern Ireland and considerable trade diversion.

The latter point refers to its interpretation of the apparent rapid growth in trade between Northern Ireland and the Republic of Ireland (Central Statistics Office, 2022). The EU, for its part, has expressed bemusement as to why the UK government is moving to breach an agreement it made as recently as late 2019.

Leaving to one side the questions of how things got to this point or whether the proposed UK legislation will be applied in any case, the UK government’s proposals have some merit as means to reduce the frictions that the Protocol has imposed on the movement of goods from Great Britain to Northern Ireland (Duparc-Portier and Figus, 2021).

The UK government is proposing a reversal of a presumption in the Protocol, meaning that it would now be assumed goods coming across the Irish Sea will remain in Northern Ireland.

There would be green and red channels, and self-declaration for checks would only apply to the latter – that is, goods moving on to the Republic of Ireland and the rest of the EU. It would be an offence in UK law to sell on into the single market/customs union without following the appropriate regulations.

As a result, the UK government is turning to some of the proposals made at earlier stages of the debate about how to handle Northern Ireland’s position post-Brexit. This includes alternative arrangements, trusted traders and mutual enforcement (Prosperity UK, 2019; Verfassungsblog, 2019).

Critics argue that such approaches are unusual and would require the EU to have a high degree of trust that the UK government will act as its agent to protect the integrity of the single market. Yet this point could also be made about the existing arrangements under the Protocol.

Views of the Protocol are also being shaped by perceptions of economic performance. Commentators including the Irish deputy prime minister and the Scottish first minister, as well as the National Institute of Economic and Social Research (NIESR) and the Financial Times, have claimed that Northern Ireland’s recent economic growth performance is better than the UK average. They go on to argue that this indicates that the Protocol has been a net economic benefit.

Both parts of that proposition – that Northern Ireland has had above average growth and that the Protocol is the explanation – are questionable (see Figure 1).

Figure 1: Recent growth of GDP in Northern Ireland compared with the UK average, 2020 Q1 = 100

Source: Northern Ireland Statistics and Research Agency (NISRA) and Office for National Statistics Note: Volume of GDP in Northern Ireland (NI) represented by the NI composite economic index.

Note that the first quarter of 2020 was the last period before the pandemic had any substantial impact on the economy. Similarly, the last quarter of 2020 was just before the implementation of Brexit (on 1 January 2021), when Great Britain left the single market but Northern Ireland remained, given the Protocol.

It is true that compared with pre-pandemic output levels, Northern Ireland has registered significantly more growth than the UK average. But much of the explanation for this pre-dates the application of the Protocol.

The Northern Irish economy suffered much less from Covid-19 than the rest of the UK (possibly because it has a larger public sector). During the year since the fourth quarter of 2020, with the Protocol in operation, Northern Ireland’s growth (5%) fell short of the UK average (6.6%).

The Protocol is likely to affect different sectors or industries in various ways. It may hurt sectors that are dependent on inputs coming to Northern Ireland from the rest of the UK but help those that buy from or sell into the Republic of Ireland or the rest of the EU. Given this, it is worth looking at the pattern of growth within manufacturing during the period of the Protocol (see Figure 2).

Figure 2: Output growth in Northern Irish manufacturing sectors, 2020 Q4 to 2022 Q1 (2020 Q4 = 100)

Source: NISRA

There is a lot of volatility in the data and other factors that may be influencing these figures. For example, the rapid decline in chemical and pharmaceuticals may reflect a reduction in Covid-19 testing.

That said, the contrast between the recent performance of food, drink and tobacco (predominantly food processing), which has most likely benefited from the trade diversion effects of the Protocol, and that of electrical engineering, which is heavily reliant on inputs from Great Britain, is striking (Duparc-Portier and Figus, 2021).

It is also worth noting that if a structural shift is happening, it is one from sectors that generally have high productivity levels – for example, branches of engineering – to ones that are generally lower value added per person, such as food products (Forth and Aznar, 2018).

It remains uncertain whether this current bill will pass. But whatever happens, any new prime minister will still need to address the challenges thrown up by the Protocol, and Brexit more generally.

Where can I find out more?

• The impact of the new Northern Ireland protocol: can Northern Ireland enjoy the best of both worlds? Paper by Geoffroy Duparc-Portier and Gioele Figus.
• What impact will the Protocol have on the Northern Ireland economy? Graham Gudgin and Harry Western on the economic effects of the Protocol.
• How is Brexit affecting Northern Ireland’s economy? Esmond Birnie and Graham Brownlow examine the effect of Brexit on the Northern Irish economy.

Who are experts on this question?

• Arnab Bhattacharjee, Research Lead at NIESR and Professor and Head of Economics at Heriot Watt University
• Graham Brownlow, Management School, Queen’s University Belfast
• Geoffroy Duparc-Portier, Fraser of Allander Institute
• Giole Figus, Fraser of Allander Institute
• Graham Gudgin, Honorary Research Associate Centre for Business Research at Cambridge Judge Business School
• Esmond Birnie, Senior Economist, Ulster University Business School

Author: Esmond Birnie

Editor’s note: This is an update of an article published on 28 April 2022.

Photo by Leonid Andronov from iStock

The post Update: What has been the economic impact of the Northern Ireland Protocol? appeared first on Economics Observatory.

The data, covering the calendar year 2020, include figures for Northern Ireland, Scotland and Wales, and the nine regions of England. Across the UK as a whole, there was a substantial year-on-year fall in total imports and exports from 2019. But there was considerable variation in the size of the decrease among different regions – see Figure 1.

Figure 1: Year-on-year percentage change in value of total trade imports and exports by ITL1 region, 2019 to 2020

Source: ONS
Note: The ‘Unknown’ category includes companies unmatched to specific regions, some offshore oil activity, non-monetary gold, government spending in trade in goods, and national imports of gambling in trade in services. The other 12 are what are known as the International Territorial Level (ITL) 1 statistical regions of the UK.

The West Midlands saw the largest year-on-year fall in total exports, at -25.3%. This decrease, seen in exports of both goods and services, may have been due to the prevalence of car (and car part) manufacturing in the region. The sector struggled significantly in 2020, in part because of a global shortage of semiconductors.

Beyond cars, both the wider manufacturing and accommodation and food service industries saw large decreases in trade during the pandemic. This is likely to have contributed to the shrink in exports seen in the West Midlands.

The East of England experienced the second smallest fall in total exports, at -4.3%. This is likely to be a result of the numerous research institutions related to medicine, pharmaceuticals and biosciences located in the region. Many of these research areas experienced a surge in demand in response to the pandemic. Overall, the professional, scientific and technical activities industry experienced a 22.5% increase in trade compared with 2019.

What happened to the UK’s trade balance?

The UK had a total trade surplus of £6.3 billion in 2020, as all four nations exported more than they imported. This contrasts with the deficit of £27.6 billion the previous year.

London was the main contributor to this, with a balance of £54.2 billion (driven by service exports). A significant proportion of these exports is likely to have come from the financial and insurance services industry. Recent analysis shows that, overall, this sector accounts for around a third of UK service exports, with half of the sector’s output generated in London.

The South East had the highest trade deficit of the regions of England, with £108.6 billion in imports. This is due in part to the presence of the Folkestone and Dover ports, as well as nearby warehousing in the region.

What happened to trade in goods?

All UK nations bar England had surpluses in goods trade in 2020, with the North East being the only region in England that was a net exporter. The South East was the largest importer of goods, accounting for 19.9% of UK goods imports.

Figure 2 shows that the value of goods imported and exported fell in all nations and regions from 2019 to 2020. London experienced the largest percentage decrease in goods imports, primarily due to buying in fewer products from countries outside the European Union (EU).

Figure 2: Year-on-year percentage change in value of trade in goods imports and exports by ITL1 region, 2019 to 2020

Source: ONS

What about trade in services?

The UK had a surplus in services trade of £135.7 billion, up from £103.3 billion in 2019. All nations and regions were net exporters of services. London accounted for 41.1% of imports and 48.5% of exports, trading in services more than any other region.

But imports in services fell in all regions from 2019 to 2020, and exports fell in ten of the 12 regions – see Figure 3. Northern Ireland was one of the two regions that saw an increase in exports, largely due to trade in financial and insurance services.

Figure 3: Year-on-year percentage change in value of trade in services imports and exports by ITL1 region, 2019 to 2020

Source: ONS

In terms of different areas of the economy, the travel industry dropped from being the largest contributor to services imports in 2019 to the fourth largest in 2020. Lockdowns and international travel restrictions caused travel imports to decrease by -71.1% on average across the UK.

Covid-19 restrictions also hurt exports of services in the accommodation and food service sector. Large decreases were seen in London, the West Midlands and the South East, in particular. This was due in part to drops in demand for retail, tourism and entertainment, as well as nationwide controls imposed on social interactions.

The new ONS data show that the pandemic had a significant impact on UK trade. It is difficult to assess the extent to which these patterns reflect short-term trade disruptions or longer-term supply chain adjustments.

The Trade and Cooperation Agreement between the UK and the EU came into effect in January 2021, as the Brexit transition period ended. It is likely that this will lead to further longer-term supply chain adjustments, and changes to UK trade patterns across the nations and regions.

Where can I find out more?

• The full data release for international trade in UK nations, regions and cities in 2020 is available here.
• Previous data for 2019 are available here.

Who are experts on this question?

• Thomas Sampson
• Meredith Crowley
• Swati Dhingra

Author: Marco Vaitilingam

The post How has the pandemic affected international trade across the UK? appeared first on Economics Observatory.

The war in Ukraine, as well as sanctions against Russia, have resulted in a massive decline in the supply of major staple foods. This has led to a rise in food prices globally.

Which countries are bearing the brunt of the crisis?

Many developing and emerging market countries rely on food imported from Ukraine and Russia – known as ‘the breadbasket of Europe’ – to augment local food production. For example, the top three importers of Russian wheat in 2018 were Turkey, Vietnam and Indonesia. Similarly Indonesia, the Philippines and Morocco imported the largest share of Ukrainian wheat that year. Instability caused by the war will therefore negatively affect the food supply in these importing nations.

Food shortages precipitated by the war are hurting food prices everywhere, with the hardest hit being developing economies where the world’s poorest live. The United Nations’ Food and Agriculture Organization (FAO) reports that the global Food Price Index (FPI) averaged 159.3 points in March 2022, up 17.9 points (12.6%) from February. This is the highest level since its inception in 1990. The latest increase reflects new all-time highs for vegetable oils (248.6 points) and cereals (170.1 points), highlighting the direct negative effect of the conflict.

Focusing on country-level statistics, the largest leap in food price inflation between February and March 2022 has been in developing/emerging regions such as sub-Saharan Africa. Several of these countries have experienced higher food price inflation than the global average (12.6%) over this period. For example, Lebanon (396%), Zimbabwe (75%) and Turkey (70%) experienced the highest rate of food price inflation between February and March (see Figure 1).

Figure 1: Developing and emerging market economies with the highest food price inflation change between February and March 2022

Source: FAO Food Price Monitoring and Analysis, 2022

Households in these countries devote a greater proportion of their total expenditure to the provision of food (see Figure 2). Specifically, the World Bank estimates that poor households in sub-Saharan Africa spend approximately 75% of their income on food. This compares with 10.8% for the average UK household in 2019/20.

Consequently, rising food prices reduce the real incomes of households, pushing more people into the food poverty trap – a situation where more individuals and households are unable to afford adequate and nutritious diet.

Figure 2: Share of income spent on food, by selected country

Source: Economic Research Service (ERS), United States Department of Agriculture

Sanctions on Russian oil companies and the planned bans on Russian energy exports have triggered further increases in energy prices in the international market. While the European Union (EU) is the largest collective buyer of Russian oil – buying 42% of Russia’s oil output in 2021 – the constituent countries have managed to diversify their economic base and begin importing more oil from elsewhere.

In contrast, many developing/emerging markets run a ‘monocultural economy’ –meaning they are highly reliant on single basic resources such as oil. For example, while oil accounts for 40% of Nigerian GDP, 70% of its budget revenues, and 95% of foreign exchange earnings, Nigeria remains the only member of the Organization of the Petroleum Exporting Countries (OPEC) that imports 95% of refined petrol for domestic use.

Consequently, movements in the international oil market affect local fuel prices in these markets. Eventually, the burden of higher costs of production, storage and transport is passed on to the consumers in the form of higher food prices.

Going back to Figure 1, countries with the highest rate of food price inflation are also often conflict-prone economies. Before the war broke out in Ukraine, some developing/emerging markets were already experiencing higher food bills due to internal conflicts or climate-related challenges.

For example, in 2016 the United Nations (UN) reported that Boko Haram bombings in Northern Nigeria disrupted trade routes between Chad and Nigeria, interrupting the supply of basic goods and causing local price hikes. It is likely that the war in Ukraine has worsened existing food price crises in some developing economies.

What next for food security around the world?

More research is needed to disentangle the extent to which current food price inflation can be attributed to internal crises in developing economies or the war in Ukraine. But we do know that the effects of both situations on food prices reinforce one another.

Situations where food becomes increasingly expensive or insufficient can incite further civil conflicts. This was seen during the Arab spring in the early 2010s – an event that emerged partly in reaction to high cereal prices. These anti-government protests in the Middle East followed international food price inflation, bad weather conditions and shrinking farmlands, together with high unemployment and dissatisfaction with the corrupt political classes.

A decade later, a similar set of factors could combine and cause both political turbulence and a further escalation of prices. The combination of fragile institutions, political instability and non-diversified economic structures are central factors that amplify the effects of the Russian invasion of Ukraine on food prices in emerging economies. Where these challenges are not addressed, it may be that food prices in these economies do not revert to the pre-crisis era, even if the war in Ukraine were to end.

Where can I find out more?

• The World Bank blog gives an insight into amplifying effect of the conflict in Ukraine on food crisis in Africa.
• The United Nations Brief provides an in-depth discourse on the impact of war in Ukraine on global food systems.
• The International Monetary Fund blog details how the war in Ukraine is affecting different sectors in several parts of the world.

Who are experts on this question?

• Lotanna Emediegwu
• Sascha O. Becker
• David Ubilava
• Alfons Weersink

Author: Lotanna Emediegwu

Photo by AndrijTer from iStock

The post How is the war in Ukraine affecting global food prices? appeared first on Economics Observatory.

For the government in Kyiv, military aid and security are immediate needs, but since membership of the North Atlantic Treaty Organization (NATO) is unlikely at present, the EU application is a symbolic move designed to strengthen the security of Ukraine against Russian aggression.

Georgia and Moldova submitted similar applications on 3 March 2022 creating an ‘association trio’. While the inclusion of these two states makes geopolitical sense – given their own political vulnerability to Russian influence and hostility – discussions about incorporating three countries of such different size, political outlook and economic development could hamper Ukraine’s urgent request.

Visiting Kyiv on 5 April 2022, the European Commission president, Ursula von der Leyen, together with the high representative of the union for foreign affairs and security policy, Josep Borrell Fontelles, presented President Zelensky with a pre-accession questionnaire. This stated: ‘It will not, as usual, be a matter of years to form this opinion but I think a matter of weeks’. President Zelensky laughed, replying that it would take his team only a week to answer the questions. A second questionnaire was completed on 9 May 2022.

It remains to be seen whether Ukraine will join the EU. This article looks at the current relationship and considers how this might change if Ukraine were to become a full member.

What is Ukraine’s current relationship with the EU?

Ukraine already has a sophisticated association agreement (AA) with the EU, which has been in place since September 2017. Additionally, since January 2016, it has been part of a deep comprehensive free trade area (DCFTA) with the EU.

The key elements of the DCFTA include:

• Mutual abolition of import duties on the majority of goods imported into each other’s markets.
• Introduction of rules of origin of goods, to facilitate trade preferences.
• Bringing Ukraine’s technical regulations, procedures, sanitary and phytosanitary measures, and food safety measures in line with EU rules, so that Ukrainian industrial goods, agricultural and food products do not require additional certification in the EU.
• Establishment of the most favourable conditions of access to the services markets of both Ukraine and the EU.
• Introduction of EU rules into public procurement by Ukraine, which will allow gradual opening of the EU public procurement market for Ukrainian businesses.
• Simplification of customs procedures and prevention of fraud, smuggling and other offences in cross-border movement of goods.
• Strengthening protection of intellectual property rights in Ukraine.

The AA also allows for goods originating in EU member states to be processed in Ukraine and re-exported back into the EU – for example, food processing.

When signing the economic section of the AA in June 2014, after the Revolution of Dignity, the (then) Ukrainian president, Petro Poroshenko, saw this moment as Ukraine’s ‘first but most decisive step’ towards EU membership. Similarly, the then president of the European Council, Herman Van Rompuy, stated that ‘In Kyiv and elsewhere, people gave their lives for this closer link to the European Union. We will not forget this’.

The economic and political aims of the AA and DCFTA were to divert trade from Russia towards the EU. This occurred alongside a process of aligning Ukraine’s laws with the EU’s acquis communautaire, modernising its financial and political institutionsand developing closer political ties.

It is often described as Ukraine ‘choosing to look west’. At the same time, it is an example of the EU using its soft power of trade as a foreign policy tool.

Russia immediately retaliated by raising tariffs against Ukrainian goods. More ominously, Russia’s president, Vladimir Putin, stated that making Ukraine choose between Russia or the EU would split Ukraine in two. The annexation of Crimea in 2014 and Russian support for separatists in eastern Ukraine were the consequence of this political shift. They were also the forerunners of the invasion in early 2022.

The AA has a political dimension to encourage dialogue between Ukraine and the EU. It requires regular summits between the president of the European Council and the president of Ukraine. Members of the Council of the EU and the cabinet of ministers of Ukraine must meet regularly, as well as members of the European Parliament and the Ukrainian parliament, and other officials and experts.

The EU has funded training programmes in EU law and lent officials for capacity-building. In hindsight, perhaps more could have been made of these political provisions in order to develop closer ties.

How have the AA and DCFTA affected Ukraine’s economy?

Statistics show that the AA and the DCFTA have had some impact on trade between the EU and Ukraine:

• The EU is now Ukraine’s largest trading partner. Conversely, Ukraine is the EU’s 15^th largest trading partner in terms of imports and 17^th in terms of exports. This accounts for around 1.1% of the EU’s total trade, reaching a value of €43.3 billion in 2019.
• Ukrainian exports to the EU amounted to €19.1 billion in 2019. The main exports are raw materials (iron, steel, mining products, agricultural products), chemical products and machinery. This figure has increased by 48.5% since 2016.
• EU exports to Ukraine amounted to over €24.2 billion in 2019, an increase of 48.8% since 2016. Machinery and transport equipment, chemicals and manufactured goods are the EU’s main exports to Ukraine.
• The number of Ukrainian companies exporting to the EU has also increased at an impressive rate: from approximately 11,700 in 2015 to over 14,500 in 2019 (European Commission).

Nevertheless, Ukraine exports only a third of its goods to the EU (World Trade Organization, WTO). In contrast, Moldova, which has a similar DCFTA with the EU, exports two-thirds of its goods to the EU (WTO).

The AA commits Ukraine to an agenda of economic, judicial and financial reforms and to gradual approximation of its policies and legislation to those of the EU. This includes conformity to the EU’s technical and consumer standards. Progress has been slower in these areas.

There have been general problems in Ukraine’s economic and social development. Writing in the Financial Times on 26 January 2022, Alan Beattie commented:

‘Ukraine, a dysfunctional economy with a woeful business climate, has failed to get itself in shape to take advantage. Nor has the EU been able to provide enough aid or crisis lending to rescue it from balance of payments problems and help it to develop. The EU has largely left it to the IMF [International Monetary Fund] to provide emergency external financing, and EU technical assistance has fallen short of expectations.’

What characteristics of the Ukrainian economy over the past three decades have hindered its progress?

The Ukrainian economy suffered severe dislocation after severing its ties with Russia in August 1991. At the time of dissolution, almost all industry and agriculture were publicly owned, with a large proportion of GDP devoted to the infrastructure of the communist state.

GDP per head in Ukraine fell precipitously until the turn of the century, before a substantial recovery in the 2000s (see Figure 1). But the period after 2007 was one of stagnation in GDP per head (as in many other countries), exacerbated by the Russian occupation of the Crimea and part of two eastern provinces of Ukraine in 2014.

Yet it should be noted from Figure 1 that this standard measure of GDP per head overstates the decline in living standards in the first and last decades. Throughout the period, the share of GDP devoted to consumption expenditure (rather than state activities, military spending and infrastructure) grew steadily, which insulated the Ukrainian population from some of the adverse economic trends.

Figure 1: GDP per capita in Ukraine (constant prices) and consumption share in GDP, 1989-2000

Ukraine GDP per capita

Consumption expenditure as % of GDP

Source: World Bank national account data

The period of stagnation in GDP from 2010 onwards also saw a sharp deterioration in Ukraine’s balance of payments on current account – the difference between the value of imports and exports of goods and services (see Figure 2). This culminated in a current account deficit of almost 9% of GDP in 2013.

Unlike some other states in Eastern Europe after the dissolution of the Soviet Union, Ukraine was unable to diversify substantially away from its traditional exports of agricultural products and raw materials. By 2014, its foreign exchange reserves only covered one month of imports, and the Ukrainian currency depreciated rapidly against the world’s major currencies, such as the dollar (see Figure 3).

Ukraine was also hindered by a lack of foreign investment. Investors were reluctant to put their money into a country that was one of the most corrupt in the world. In 2015, Transparency International ranked Ukraine 130^th out of 168 countries in its Corruption Perceptions Index.

Figure 2: Balance of payments on current account for Ukraine, 2000-2020

Source: International Monetary Fund (IMF) financial statistics

Figure 3: Value of Ukraine’s currency to the dollar and foreign exchange reserves in months of imports

1 US$ = Ukraine currency (HRY)

Foreign currency reserves: months of imports

Sources: IMF financial statistics

What rescued Ukraine’s economy in the latter part of the period, other than some modest internal improvement in domestic economic conditions, was the flow of incoming remittances from the substantial number of Ukrainians working abroad.

These remittances rose substantially during the period, especially after 2014 given the underlying economic conditions and political dislocation arising at that time (see Figure 4). The share of GDP accounted for by remittances from Ukrainians abroad rose from 1% of GDP in 2000 to around 10% two decades later. The contribution of remittances to real consumption expenditure – and hence, to maintaining living standards – was even greater.

Figure 4: Remittances from Ukrainians abroad, 2000-2020

Source: World Bank

The question of EU accession is not therefore primarily a question of increased trade opportunities. It encompasses, crucially, a change in the investment environment and also the question of labour migration. Of the ‘four freedoms’ of the EU’s internal market (goods, services, capital and people), it is the last two that may prove crucial in negotiations and to the Ukrainian economy.

What would be required for Ukraine to join the EU?

The recent request for a special procedure has come as a result of the war in Ukraine. President Zelensky was mindful that a number of states, most notably Turkey, have been waiting to join the EU for a number of years, with accession agreements stalled.

While the EU has shown an interest in an integrated relationship with Ukraine since independence in 1991, it is only when crises hit the region – for example, the Orange Revolution of 2004-05, the invasion of Georgia in 2008 and the Revolution of Dignity in 2013-14 – that the EU has stepped up its interest in developing a political relationship with Ukraine (Bélanger, 2022).

The Russian invasion has changed the narrative of EU membership beyond issues of economic integration to those of political and social integration and security.

The first dimension of the accession process is political. It requires stable institutions and abiding by the values of respect for human dignity, freedom, democracy, equality, the rule of law and respect for human rights, including the rights of persons belonging to minorities. A prospective state must also show that it is capable of adopting the body of EU legislation (acquis communautaire) into its national system.

In addition, a state must satisfy economic criteria. The existence of a functioning market economy as well as the capacity to cope with competitive pressure and market forces within the union are the broad requirements that would be assessed by the European Commission.

There was widespread support for accession to the EU within Ukraine and most EU member states responded positively to the idea. But France’s president, Emmanuel Macron, has suggested that Ukraine should continue with the looser association status, likening Ukraine’s future relationship with the EU to that of the UK.

Some political commentators have also argued that Ukraine is not ready to shoulder the responsibility of EU membership, and the EU is not in a position to take on board Ukraine’s internal problems.

On 1 March 2022, the European Parliament recommended that Ukraine be made an official ‘candidate’ for EU membership and ten days later, the Versailles Declaration attempted to bring all EU member states on board to initiate an accession process.

Using data drawn from the AA and the DCTFA as the basis for accession is likely to be the easiest way to begin the process. These existing agreements can also provide the framework for the accession treaty (Van Elsuwege and Van der Loo, 2022).

How might EU membership improve on the AA and the DCFTA?

Unlike the AA and the DCFTA, membership of the EU would give Ukraine presence in the EU institutions – the European Parliament, the European Commission, judges and an advocate general in the European Courts. Ukrainian would also become an official language of the EU.

Ukrainian citizens would benefit from the principle of non-discrimination, enhanced free movement rights and family rights to move to work, study, settle, retire and gain access to social security benefits across the EU.

EU law would take supremacy in Ukrainian courts and would, in some cases, be directly applicable. Where the conditions are met for direct effect, individuals and legal entities (corporations) will be able to assert EU law rights in national courts. Ukrainian courts would be able to ask for preliminary rulings from the Court of Justice of the EU.

The EU budget would also need adjustments. It would be difficult to expect Ukraine to pay into it, but the resources it is likely to need to rebuild after the war would have an impact on EU budgetary priorities. The EU has already created special funds for Ukraine and would be likely to ask for outside contributions from the global community for a special rebuilding fund to offset the burden (EU Law Live, 2022). The issue of reparations and the use of Russian assets currently frozen abroad will no doubt be a live issue.

What might be the economic effects of Ukraine’s accession to the EU?

As suggested above, the existing AA and DCFTA agreements largely allow for tariff-free entry of goods to and from the EU. Further, given that bulk goods, such as agricultural products and raw materials, form the majority of Ukraine’s exports, Russia will continue to be able to disrupt such shipments, especially through Black Sea ports.

Even after the cessation of overt hostilities on land, this is going to limit the scope for rapid expansion of such trade with the EU. Since Ukrainian exports of services are minimal, the main focus of Ukraine post-EU accession would be on capital inflows and labour outflows. As it stands, we could expect further negotiation on investment standards and on Ukraine’s ability to stamp out corruption as part of any accession negotiations. The sources of capital for reconstruction will no doubt extend beyond the remit of the EU, and involve other international organisations and the question of reparations from Russia.

Issues of labour migration have been complicated by the large number of refugees from Ukraine who are currently housed in bordering EU countries and for whom returning to Ukraine may prove to be a drawn out process.

One of the striking aspects of Ukraine’s pattern of migration, even before the invasion, is the shift in destination of Ukrainian emigrants. Prior to 2014, Russia received the largest share of Ukrainian migrants.

But even before the occupation of Crimea and parts of the provinces of eastern Ukraine, the pattern of migration was shifting towards the EU (see Figure 5). In 2012, the primary destinations of Ukrainian migrants were Russia, Poland and Italy (International Labour Organization). By 2017, Poland had overtaken Russia and become the dominant recipient of Ukrainians (Centre for Economic Strategy).

Estimates from surveys of Ukrainian households indicate that migrants to Poland increased from around 200,000 to 900,000 in the period 2012-17, and that up to 2.9 million Ukrainians were working abroad at any one time (typically for relatively short periods). Further, these workers were relatively unskilled and around four million Ukrainians were engaged in this form of ‘circular migration’ (Centre for Economic Strategy, CES).

Figure 5: Destinations of Ukrainian migrants, 2012 and 2017

Destination of Ukraine migrants 2012

Destination of Ukraine migrants 2017

Sources: International Labour Organization, Centre for Economic Strategy

The likelihood that many of these short-term migrants do not hold valid EU residence permits is confirmed by official EU data. According to Eurostat, at the end of 2020, 1.35 million Ukrainians held valid residence permits for the EU: around 500,000 for Poland, 223,000 in Italy, 166,000 in the Czech Republic, 95,000 in Spain and the rest elsewhere, mostly in Germany and Central and Eastern Europe.

Most of these were issued for an initial period of less than 12 months but were often extended. It is clear that, unless the CES survey figures of migrant numbers are overestimated, many Ukrainian migrants, especially in Poland, are ‘under the radar’.

Ukrainian migrants complain that they are used as cheap manual labour in the EU, paid significantly less than EU natives. The CES provides survey data on the wages of Ukrainians in 2017 both in Ukraine and recipient countries. Not surprisingly, Ukrainians abroad earn a premium relative to wages in their own country (especially wages outside Kyiv), but wages are typically below those of local workers abroad, especially in Poland.

Figure 6: Average salary of migrants in dollars, monthly, 2017

Source: Centre for Economic Strategy

The question therefore arises as to whether the EU will want to implement transitional arrangements under which free movement of labour from Ukraine would be restricted for a period subject to national law in EU states. For example, the 2005 Act of Accession for Romania and Bulgaria permitted EU member states temporarily to restrict free access of workers from these countries for a period of up to seven years, although such workers should still be given preferential access over workers who were nationals of non-EU states.

The quid pro quo is, of course, that workers who are given access from accession states should have the same rights in terms of pay and other conditions of employment contract as other EU nationals irrespective of any restrictions on numbers.

The situation is further complicated by the fact that countries such as Poland will continue to host an influx of Ukrainian citizens who are not there as workers but as refugees, including children and the elderly, for a currently unknown period of time. Hence, there will need to be detailed negotiations as to how ‘free movement of labour’ is to be applied in the context of Ukraine.

Conclusion

Membership of the EU would bring economic benefits for Ukraine. These would be felt less in terms of trade in the short term, but regularising migration and migrants’ wages would be important.

Joining the EU would also place an administrative burden on an already stretched Ukrainian government and parliament, including the need to fast-track aspects of the EU acquis communautaire and monitor the observance of EU law and policy, particularly in relation to investment incentives and contracts.

Any accession treaty will be likely to contain transitional periods, especially for full free movement of labour, and opt-out clauses. The symbolism may be that Ukraine will be given the status of ‘membership of the EU’, rather than associated or affiliated status.

But the impact of the Russian invasion of Ukraine and its request for EU membership has altered the perception of the role of the EU in international diplomacy. In particular, the EU has come to realise the need to strengthen its own security and manage its internal problems – ranging from the consequences of Brexit to the handling of alleged breaches of the rule of law by Hungary and Poland.

The war in Ukraine has ignited a catalyst for change across the whole of Europe and this may be reflected in how EU member states and the European Commission handle the question of accession by Ukraine.

Where can I find out more?

• Ukraine: EU trade realtions with Ukraine, European Commission.
• What prospect is there of Ukraine joining the EU? EUROPP.

Who are experts on this question?

• Roman Petrov
• Steve Peers
• Peter Van Elsuwege
• Guillaume Van der Loo

Authors: Richard Disney and Erika Szyszczak

Authors’ note: Erika benefited enormously from discussions from an online seminar held on 5 April 2022 with Ukrainian students, Oksana Holovko-Havrysheva and Kyseniia Smyrnova, sponsored and hosted by EU Jean Monnet projects at the Ivan Franko National University of Lviv and the National University Kyiv-Mohyla Academy.

Photo by artJazz from iStock

The post Ukraine’s accession to the European Union: what difference would it make? appeared first on Economics Observatory.

Figure 1: The GDP cost of the war for the global economy

Source: National Institute Global Econometric Model (NiGEM) simulations

These costs are going to be felt acutely in Europe. This is partly because the conflict poses a direct security threat in Ukraine’s immediate neighbourhood. European countries will need to ramp up public spending to support the flow of refugees from Ukraine, as well as investing heavily in their militaries to ease security concerns.

While this increased spending could limit the adverse effects on European GDP, it is likely to add to pressure on resources and will drive up inflation (see Figure 2).

Figure 2: The inflation cost of the war

Source: NiGEM simulations

While Ukraine is not a significant trading partner for any major economy, Russia has a great exposure to the European Union (EU). Russia and Ukraine are important suppliers of certain commodities, including titanium, palladium, wheat and corn. There are growing concerns around supply chain problems for users of these materials, including car, smartphone and aircraft manufacturers.

The impact of the conflict on commodity prices, and thus household expenditure, is more relevant than the risk of contagion from other countries' trade links. In NIESR’s Spring 2022 Global Economic Outlook, we quantified these transmission channels using the National Institute Global Econometric Model (NiGEM).

According to the model, Russian GDP will contract by more than 10% in 2022, compared with our Winter (pre-conflict) 2022 baseline. The war is also expected to shrink the Ukrainian economy by more than 30% and reduce global GDP by about 1% in 2022. Europe is still going to be the region affected most, given trade links and reliance on energy and food supplies, as well as its proximity to Ukraine. GDP in Europe is expected to shrink by more than 1% in 2022 compared with the forecast base (Figure 1).

The war will contribute to a deep Russian economic recession, with GDP set to shrink by 12 percentage points in 2022 compared with the Winter 2022 estimates (that is, -9.1% in 2022 compared with +3.2% forecast in February for the same year), and contracting by a further 11% in 2023. The overall effect on Russia’s GDP will not be cushioned entirely by the country’s higher revenues from energy exports.

We continue to expect higher commodity prices because of the disruption to food and other exports from Ukraine, and the sanctions imposed on exports from Russia. Our modelling assumptions suggest that the war has led to a 30% increase in oil prices, a 90% increase in European gas prices and a 17% increase in food prices. Figure 2 suggests the war will raise global inflation by about 2% in 2022 and 1% in 2023, compared with the February 2022 forecast.

Russian inflation will approach 20% in the second quarter of 2022 due to higher import prices. The adverse effects will result in lower confidence, weaker real incomes and disrupted trade. If sanctions were to be extended to Russian energy exports, the implications for the Russian economy would be much more severe, but the cost to the West would be still higher energy prices and a bigger growth hit, increasing the chances of recession accompanying significantly stronger inflation.

Which sectors are most at risk?

Food

According to the US Department of Agriculture, Russian and Ukrainian wheat exports are about a quarter of the global total. There are also significant exports of corn and other coarse grains, with Ukraine and Russia accounting for nearly a fifth of global exports. Around 80% of global sunflower oil exports are from Ukraine and Russia.

Sanctions and disrupted supplies could lead to higher prices for wheat and other grains, adding to already strong inflationary pressures in the global economy. There could also be adverse political implications in some emerging economies that rely on imported grain and where food represents a high share of household spending.

In the UK, bread and cereals have a weight of 2.1% in the consumer price index (CPI). While flour prices move closely with wheat prices, this is less true for bread (where the cost of production, ingredients, packaging and advertising mean that flour is a relatively small proportion of the cost of a loaf).

But higher energy costs mean that the cost of baking and transporting bread has risen, and with global supplies already tight, retail prices are likely to increase too. Higher food prices could have a much more serious effect on emerging markets such as Egypt and Bangladesh, where food is a much larger share of the CPI basket.

Retail

Russia is a major producer of palladium, used in engine exhausts to reduce emissions. Russia produces 40% of global mine production, and controls about 10% of global platinum supply. Russia and Ukraine also produce about 15% of the global supply of titanium sponge, used in aircraft. Russia accounts for about 13% of global fertiliser supplies.

Disruptions to global supplies of these commodities, together with existing supply chain problems after the pandemic, have the potential to cause heavy disruptions to specific industries and prolong shortages, keeping retail prices high.

Energy

Russia is one of the world’s largest oil producers and energy exporters. As the war continues, the West may soon target Russia’s ability to export oil and gas. Such sanctions will lead to an escalation on energy prices. We have already seen the Brent oil price surge to over $120 per barrel, the highest since 2014 (see Figure 3). Changes in crude oil value represent about 40% of the changes in the cost of fuel at the pump in the United States, but far less in Europe (where the tax is significantly higher).

Figure 3: Brent oil price

Source: Refinitiv Datastream

Financial markets and expectations

Share prices have been adversely affected by uncertainty over Ukraine, knocking billions off the value of the FTSE 100 and prompting a run to safe-haven assets like the dollar and US government bonds.

The war is causing an increase in uncertainty and country-specific risk, particularly in countries close to the conflict. This depresses demand further by deterring investment. Inflation expectations are likely to increase as the result of new supply side disruptions and increasing energy costs.

What are the main risks associated with the war?

Trade restrictions and technological bans on Russia

More than 80% of Russia's daily foreign exchange transactions and half of its commerce are in dollars. The United States, the EU, the UK, Australia, Canada and Japan have all begun to target banks and rich individuals, while Germany has put a stop to a major Russian gas pipeline project.

Russian central bank reserves abroad have been frozen, and its commercial banks have limited access to the international payments system SWIFT (although energy transactions and payment of gas bills will still be allowed).

These sanctions are more severe than those imposed in 2014 following the Russian annexation of Crimea. They have been deployed in a first tranche, targeting some of Russia’s state-owned banks and blocking Russia from trading in its debt on US, European and Japanese markets.

The EU is also restricting access to European capital markets, preventing access to funds stored by EU banks, and prohibiting commerce between the EU and the two rebel-controlled territories. A partial closure of SWIFT to some Russian banks and the freezing of Russian central bank assets highlight the importance of Western banks’ claims on Russian entities, which are concentrated in Austrian, French and Italian banks, according to the Bank for International Settlements (BIS). Russian bank subsidiaries outside Russia are facing severe stress, according to the European Central Bank (ECB), and may be forced to close.

Russia might face a prohibition on financial transactions involving dollars, as well as a restriction on hi-tech commerce with the United States and Europe. The United States, for example, could prevent corporations from selling semiconductor microchips to Russia. This would not only affect Russia's defence and aerospace sectors (accounting for $6.25 million worth of Russia’s imports), but its whole economy.

Overall, economic sanctions could result in a curtailment of Russian imports of up to 50% from Europe and the United States, although the extent of circumvention of restrictions through increased trade conducted through third countries makes this difficult to gauge.

Inflation

Significantly higher energy prices will feed into inflation. In the United States, for example, energy accounts for 7.6% of the CPI, with energy commodities, such as fuel, accounting for 4% and energy services such as electricity and piped gas 3.3%. In the UK, electricity, gas and other fuels account for 3.3% of CPI, with fuels and lubricants accounting for a further 2.7%.

Because many of the world's largest economies (such as China, Japan and Europe) are net energy importers, increased oil costs will limit global growth. The US is self-sufficient, but higher oil prices through higher bills and fuel costs will squeeze real household incomes, affecting demand in the economy.

While higher oil prices will increase the income of energy producers, this might not be spent immediately. It will not be enough to offset the negative effect on demand through lower consumption and investment, meaning that global GDP will remain subdued for some time.

Higher European public expenditure on refugees

The United Nations High Commissioner for Refugees (UNHCR) estimates that approximately six million people have fled Ukraine since the start of the war.

In the shorter term, there is likely to be considerable further migration from Ukraine into Western Europe, with Poland among the most important recipients in the first instance. Depending on what border controls are erected in Ukraine, how long the conflict lasts and how the economy settles down after the war, large scale emigration seems likely. This will present substantial challenges, mainly for Western Europe, in terms of their public finances, as well finding homes, providing jobs and school places, and promoting integration.

Higher European public expenditure on defence

The conflict is also expected to lead to an increase in spending on defence. This will present considerable fiscal problems. For example, NATO EU countries that are particularly exposed to the crisis, such as Germany, have already boosted military spending to 2% of GDP.

There is a strong likelihood that defence spending will increase in NATO over the next few years, particularly in Western Europe, where most countries do not meet the NATO target of a spend of 2% of GDP, with the average being 1.6%. There is also a chance that NATO’s membership will increase, with both Finland and Sweden recently applying to join, following long periods of historical military neutrality.

Political risk and uncertainty

The Russian invasion has challenged many Western assumptions about the post-Cold War order. Many argue that the invasion symbolises a shift in global power and a move away from the unipolar world that emerged following the collapse of the Soviet Union. This shift has led to increased uncertainty, which may drive up savings ratios and make firms more reluctant to invest.

The crisis can also be seen as another potential challenge to globalisation, coming after trade disputes and Covid-19. This might mean that manufacturers are tempted to reshore some facilities, reducing their reliance on international networks.

Exchange rate risk (the lack of)

Increasing announcements of Western corporate withdrawals from Russia are leading to outflows of capital. While officially the rouble has regained its value since the end of March, thanks partly to capital controls and the government only accepting roubles for European gas instead of euros and dollars, the unprecedented actions against the Russian central bank have hurt the Russian banking system. These effects remain difficult to quantify, but they suggest that the risks to our Russian GDP growth outlook are on the downside and on inflation on the upside.

What next?

Vladimir Putin’s demands in recent weeks have extended beyond Ukraine. It should be expected that he will use any military victory to pressure NATO for concessions elsewhere in Eastern Europe, with the clear threat that if it does not get what it wants, further aggression is likely.

This suggests that the world is now likely to face an extended period of high tension, where Russia repeatedly tries to strong-arm the West. Those tensions will increase if, after a potentially successful occupation of Ukraine, arms flow to Ukrainian resistance groups from neighbouring countries.

The war represents a challenge for the global economy. It calls into question monetary policy-makers’ strategies since it will simultaneously harm growth and put upward pressure on inflation, which is already at high levels.

In the short run, higher interest rates cannot mute the higher prices resulting from the war and could exacerbate any fall in confidence and activity. Longer term, lower demand will help to mute the second-round effects on higher prices.

The first Gulf War contributed to a recession in the early 1990s and its end helped the recovery. So, for policy-relevant horizons, interest rates will need to rise to keep inflation under control, but perhaps not so much as to induce a recession in economic activity.

The dilemma for monetary policy will intensify if inflation remains higher but recession threats mount, risking a return to the stagflation seen in earlier decades. Shares and cryptocurrencies have already shown distress and high-yield markets are under strain. The risk of a global recession might become acute if financial markets, which have priced in a very different scenario from that which is currently unwinding, were to dislocate.

Where can I find out more?

• War in Ukraine: what are the options for Europe’s energy supply? The Economics Observatory.
• The economic costs of the Russia-Ukraine conflict: National Institute for Economic and Social Research policy paper by Iana Liadze, Corrado Macchiarelli, Paul Mortimer-Lee and Patricia Sánchez Juanino.
• The impact of rising oil prices on US inflation and inflation expectations in 2020-23: Federal Reserve Bank of Dallas, working paper.
• Oil shocks and the UK economy: the changing nature of shocks and impact over time, Bank of England working paper by Stephen Millard and Tamarah Shakir.
• Re-evaluating the Economic Costs of the Russia-Ukraine Conflict in NiGEM, National Institute Global Economic Outlook - Spring 2022 (NiGEM Topical Feature I) by Iana Liadze, Corrado Macchiarelli and Patricia Sánchez Juanino.
• The Ukraine war intensifies the dilemma facing monetary policy-makers by simultaneously harming growth and exacerbating already high inflation, LSE British Politics and Policy by Corrado Macchiarelli.
• Gas prices and price controls, National Institute UK Economic Outlook – Winter 2022 (Box C) by Paul Mortimer-Lee and Urvish Patel.

Who are experts on this question?

• Erkal Ersoy
• Iana Liadze
• Corrado Macchiarelli
• Stephen Millard
• Paul Mortimer-Lee
• Patricia Sanchez-Juanino
• Pascal Seiler

Author: Corrado Macchiarelli

Photo by Evgenii Emelianov from iStock

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For example, below a picture of Reykjavik’s mountainous skyline, a recent op-ed in the pro-independence newspaper The National declares that ‘it is widely accepted that smaller nations are actually better at creating healthy political and economic systems’.

Unionists are more sceptical. They warn that low populations deprive smaller states’ governments of economies of scale. This makes public sector spending relatively more expensive in smaller states, requiring higher taxes.

Supporters of the Union also point to the experiences of small states like Iceland and Ireland in the wake of the global financial crisis of 2007-09 as a reminder of their vulnerability to fluctuations in the global economy (Harvey, 2017).

Research on small states in Europe and beyond can advance this debate. In this article, we review social science research on small states in domestic and international affairs. Most of this work defines size by population, and categorises small states as those with populations of fewer than 1.5 million residents.

By these measures, Scotland – with a population of close to 5.5 million – is not a small state. Nevertheless, size is relative. Small independent states are a useful lens through which to envision an independent Scotland.

We move beyond adjudicating whether smaller is better for political and economic development by highlighting the challenges and opportunities confronting small states. The prosperity of these states depends on their leaders’ ability to forge collaborative and cooperative relations in domestic and international politics.

Small states and local governance: pitfalls and potentials

Are smaller states better governed than larger ones? Evidence is mixed if ‘good governance’ is defined by the rule of law. Some find that small states, especially islands, are less corrupt than larger ones (Congdon Fors, 2014; Olsson and Hansson, 2011; Xin and Rudel, 2004).

Others argue the opposite: smaller states are more prone to clientelism and less professional bureaucracies (Corbett, 2015; Gerring and Veenendaal, 2020). Sceptics also warn that missing data on smaller states lead to a bias in analyses, showing that small states have better governance (Knack and Azfar, 2003).

This mixed evidence suggests that small size may have competing effects on good governance. On the one hand, smallness may strengthen public sector accountability because citizens can monitor bureaucrats’ behaviour more easily.

At the same time, smallness may blur the lines between state and society, abetting favouritism because ‘everybody knows everybody’ (Corbett, 2015). It is paramount for leaders of small states to capitalise on the accountability benefits of smaller polities while suppressing temptations for favouritism (Mungiu-Pippidi, 2015).

Evidence of smaller being better is also mixed if good governance is defined by bureaucratic capacity. There is a trade-off between size and administrative effectiveness (Jugl, 2019). Bureaucracies in smaller states do not benefit from economies of scale: they can be over-stretched and under-specialised.

Yet bureaucracies in smaller states do profit from easier communication and coordination among state institutions and the public. As a result, the evidence suggests that medium-sized countries can have the most effective bureaucracies, all else being equal, while very small and very large countries perform less well (Jugl, 2019).

Measured on a population basis, an independent Scotland with a population of close to 5.5 million would fall below this ‘golden mean’ of population size, which the study estimates at between 15 and 94 million (Jugl, 2019).

This suggests that, all else remaining equal, an independent Scotland would have to be mindful of administrative effectiveness and take action to avoid efficiency losses, which the evidence suggests have been a feature of some countries of a similar size.

Overcoming these losses would require stronger communication and coordination between agencies and departments, and a greater focus on common goals and ‘big picture’ questions. Some smaller European countries – such as Estonia, Iceland, Latvia and Luxembourg – have mastered this challenge (Sarapuu and Randma-Liiv, 2020; Jugl, 2020). With a committed leadership and civil service, Scotland could do so as well.

Figure 1: Countries according to their size and government effectiveness

Source: Jugl, 2022

Note: hover mouse over each point to see underlying country data

Clean and effective governance would be especially important for a newly independent Scotland because of its resource wealth. Petroleum and related products – but also increasingly renewable energy resources – are a staple of the Scottish economy, and the country’s primary export.

Whether in Scotland or New Caledonia, proponents of independence argue that their territory’s resource abundance can propel their newly independent state’s fledgling economy. But are smaller states better at managing resource wealth?

Scholars have long debated whether, when and under what conditions resource abundance is a blessing or a curse (Ross, 2015). Among smaller states, Norway, with a comparable population to Scotland, is a paragon of sound resource governance. The eponymous ‘Dutch disease’, on the other hand, suggests that smaller economies can be more susceptible to the economic consequences of resource abundance.

Economists blame the discovery of natural gas in the Netherlands for causing the Dutch currency to rise against other currencies. This exchange rate appreciation made imports cheaper and Dutch exports dearer, heightening the decline of Dutch manufacturing. Countries with larger domestic markets, which are less dependent on international trade, are more insulated from these resource-backed currency fluctuations.

The economic success of some resource-abundant small states (and the failures of others like Equatorial Guinea) highlights that natural resources can be a lever or impediment to growth. Checks and balances, clean and effective bureaucracies, savings mechanisms like sovereign wealth funds and partnerships with local and international monitoring groups, like the Extractive Industries Transparency Initiative (EITI), can help newly independent small states to manage their resource wealth effectively and equitably.

Moving beyond resource wealth, and contrary to claims in The National op-ed, researchers disagree whether smaller is better for economic development. Some find a positive relationship (Anckar, 2020) and others no relationship between small size and economic development (Easterly and Kraay, 2000; Gerring and Veenendaal, 2020).

Still others maintain that small size at independence, when economic and political arrangements are first forged, is a powerful predictor of long-term development (Bin Khalid et al, 2022).

A seminal work in this area – The Size of Nations – argues that trade with larger markets erases inherent economic disadvantages of smaller population size. This work on size and development recalls that economies do not exist in a vacuum; policy-makers and policies shape small states’ economic wellbeing (Alesina and Spolaore, 2003).

They need smart, flexible, collective and responsive policy-making, especially when economic integration exposes small states’ economies to the volatilities of globalisation (Baldacchino, 2020).

Another study of small European states examines the domestic politics buttressing small states’ integration into the global economy (Katzenstein, 1985). This analysis of seven small West European states with populations comparable to Scotland – Austria, Belgium, Denmark, the Netherlands, Norway, Sweden and Switzerland – reveals that close, continued cooperation between the state and heads of unions and business associations sustain small states’ economic integration.

This close cooperation engenders generous welfare programmes that compensate those disadvantaged by economic openness. It also breeds a social mindset that ‘all members of society are in the same small boat, that the waves are high, and that everyone must help pull the oars’. Social solidarity in norms and governance are vital for small states’ prosperity in world markets.

Building from this insight, more recent work explores how governments in small West European states, especially Denmark and Switzerland, navigated the global financial crisis of 2007-09 (Campbell and Hall, 2017). The authors introduce a ‘paradox of vulnerability’: it is precisely the repeated experience of economic volatility and shocks – but also other external challenges such as military (see below) or political threats – that force small states to develop resilient state structures.

These well-designed and robust structures, based on values like expertise, accountability and collaboration, help small states and their governments to deal with new crises and challenges like the global financial crisis.

Importantly, the authors use the cases of Greece and Ireland to demonstrate that resilient governance structures do not follow automatically from smallness but from exposure to external threats. Time is needed to build resilient structures and develop national solidarity.

Small states in the international arena: vulnerability and cooperation

Conventional international relations scholars argue that vulnerability anchors small states’ foreign policy. Fears of conquest and bullying by larger neighbours push smaller states into alliances with hegemons like China, Russia and the United States, or into absolute neutrality, as in the case of Switzerland (Archer and Nugent, 2002; Goh, 2007).

Others question smaller states’ inherent acquiescence. Both Iceland and Malta successfully confronted the UK in disputes on fishing rights and developmental assistance in the 1970s (Baldachinno, 2009). More recently, Lithuania’s decision to open a Taiwanese representative office and Baltic states’ military aid to Ukraine illustrate that small states can stand up to larger states.

International organisations can also help small states to solve their security challenges (Bailes and Thorhallson, 2013). They amplify small states’ influence by providing a venue to organise and lobby larger states collectively. For example, the Forum of Small States is an informal group of small state representatives that meets regularly to discuss small state concerns and share best practices.

But small states’ ability to leverage regional and international organisations to advance their interests depends on the quality of their diplomatic corps. Many small states lack the staff and expertise to participate effectively in these multinational forums (Corbett and Connell, 2015).

International organisations can also help small states to solve their economic challenges (Lake and O’Mahoney, 2004). Economic openness and trade dependency are defining features of small state economies (Rigobon and Rodrik, 2005; Alesina and Wacziarg, 1998).

This is because smaller economies lack a large domestic labour force to produce goods, and a large domestic market to consume goods. Imports make up a large share of consumed goods, while exports make up a large share of produced goods. This means that small economies are more dependent on world markets.

Because of their greater trade dependency, protectionist policies are particularly costly for consumers and producers in smaller economies. Therefore, leaders of smaller economies face strong domestic pressures to open domestic and foreign markets. Joining international organisations like the World Trade Organization (WTO) and the European Union (EU), which deepen trade integration, is a boon for small states’ economic development.

In the context of independence referendums, the main lesson from research on small states is for newly independent states to keep good relations with their neighbours. Secessionist states are likely to have deep economic ties with the state they left and neighbouring ones.

Returning to Scotland, four out of the country’s top five international export markets are in the EU. But 60% of Scottish exports go to England, Wales and Northern Ireland.

Because of smaller states’ higher trade dependency, maintaining trade flows with the UK and Europe would be existential for an independent Scotland’s economic wellbeing. This may require an independent Scotland’s admission into the EU, although whether EU member states would accept an independent Scotland into the union is open to debate.

Conclusion

This overview of evidence on the performance of small states should caution any knee-jerk optimism (or pessimism) about Scotland’s political and economic viability as a small independent state.

The blessings and afflictions of small population size are contingent on local and international politics. Reaping the benefits of small size in domestic affairs while mitigating the costs demands deep collaboration and solidarity between state and society.

Thriving in the international arena – one dominated by larger states – requires diplomatic tact and international cooperation. These demands are obtainable, but not inevitable.

Scotland’s success as a small independent state would depend less on its size than on its leaders’ ability to leverage the benefits and lessen the liabilities of small population size.

Where can I find out more?

• Scotland as an independent small state: Where would it seek shelter?
• What Dutch disease is, and why it’s bad.
• Small states and small states revisited.
• Country size and public administration (video abstract).
• Democracy in small states: why everything we think we know about democratisation is (mostly) wrong.

Who are experts on this question?

• Godfrey Baldacchino, University of Malta
• Jack Corbett, University of Southampton
• John Connell, University of Sydney
• John A. Hall, McGill University
• Malcolm Harvey, University of Aberdeen
• Külli Sarapuu, Tallinn University of Technology
• Baldur Thorhallson, University of Iceland
• Tiina Randma-Liiv, Tallinn University of Technology
• Wouter Veenendall, Leiden University

Authors: Marlene Jugl and Steve L. Monroe

Editors' note: This article is part of our series on Scottish independence – read more about the economic issues and the aims of this series here.

Photo by leonardospencer from iStock

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Economists should be all over the workings of the Northern Ireland Protocol, which was introduced at the beginning of 2021 following the UK’s exit from the European Union (EU). In practice, commentary on the economic cost of the Protocol – which allows goods to cross the border from Northern Ireland into the Republic of Ireland without checks – has been rather muted.

This may be because the Protocol has become a politically charged issue. But in addition, data on the size of trade flows and associated costs since its implementation remain limited. For the period since 1 January 2021, when the Protocol began to operate, the only data available are those produced by the Republic of Ireland’s Central Statistics Office (CSO) on north-south trade on the island of Ireland. 

For trade in goods between Northern Ireland and the rest of the UK, the most up-to-date data – from the Northern Ireland Statistics and Research Agency (NISRA) – is for 2019 (see Tables 1 and 2). Although data for goods and services combined for 2020 are available, the 2021 data will not be available until the end of this year. 

Our preference is to use NISRA-type data. Rather more up-to-date data (VAT-related, from HM Revenue and Customs) are available from the Office for National Statistics (ONS), but there are indications that this may be less reliable because of the use of UK-wide data apportioned out to the regional level. 

Table 1: Northern Ireland economy sales, external sales and exports (£ billion), 2019

Source: NISRA, 2021

Table 2: Northern Ireland economy purchases and imports (£ billion), 2019

Source: NISRA, 2021

For context, according to CSO data, exports from the Republic of Ireland to Great Britain in 2021 (€14.4 billion) increased by 17% compared with 2020. In contrast, imports to the Republic of Ireland from Great Britain in 2021 (€15.4 billion) were 13% lower than in 2020. 

This article sets out what we know about the economic impact of the Protocol, whether positive or negative. 

What is the Protocol and what has it meant in practice?

In late 2019, as part of the broader withdrawal agreement between the UK and the EU, special arrangements were made for Northern Ireland. A hard economic border between Northern Ireland and the Republic of Ireland was avoided and, as a result, Northern Ireland remains part of the EU’s single market and customs union for goods. 

But how could the EU prevent businesses in Great Britain from using Northern Ireland as a back door entry into the single market? 

It was agreed that goods coming into Northern Ireland from the rest of the UK would be checked to ensure compliance with the tariff and non-tariff aspects of the EU’s single market and customs union. Protocol checks or, indeed restrictions, are especially important with respect to food products – Northern Ireland applies the EU’s sanitary and phyto-sanitary (SPS) standards. 

Some of the checks and controls have been mitigated by ‘grace periods’. For example, parcels sent from Great Britain to Northern Ireland that are worth less than £135 are exempt from customs procedures. Further, the EU SPS rules would have resulted in an outright ban on imports of certain meat products, but the UK government unilaterally suspended such bans. As of mid-2021, the EU estimated that only about 30% of required veterinary checks were actually happening. 

The Protocol stated there should be ‘unfettered access’ to Great Britain’s internal market. In other words, there should be no formal trade barriers against Northern Irish firms selling into the rest of the UK. But this does not exclude the possibility that Northern Irish firms would become less competitive in the British market given any additional costs imposed through the Protocol (as discussed below). 

What are the costs to businesses, consumers and government?

In 2018 – ahead of the introduction of the Protocol – forecasts by HM Treasury suggested that international experience indicated that borders produced a cost increase of somewhere between 5% and 11% through non-tariff barriers.

Four businesses (Marks and Spencer, Allen Logistics and two anonymous businesses reported in the House of Lords sub-committee on the Protocol) and one trade association (Horticultural Trades Association) have posted data from which the cost impact of the Protocol can be estimated. 

From these five examples, it is estimated that the cost averages at least 6% of general costs, which is at the lower end of the Treasury forecast. Given that the total annual value of goods from Great Britain purchased by Northern Ireland is about £11 billion (see 2019 data in Table 2), this implies that even if the Protocol increases costs by only a small amount, say 2-3%, this translates into extra costs of several hundred million pounds annually. 

That is to say nothing of cases where, since 2021, British firms have withdrawn completely from the Northern Irish market or reduced their product range there. Research by the Consumer Council indicates that at least 200 British companies no longer send products to Northern Ireland (Consumer Council, 2021).

Consumers also face costs as a result of the Protocol. Currently, retail in Northern Ireland is well integrated into supply chains for the rest of the UK. In logistical terms, it is part of a national market of about 68 million people and its associated economies of scale. 

But if supply chains between Northern Ireland and the Republic of Ireland were to increase in importance, then we would be talking about a smaller unit (that is, two million plus five million people) and hence economies of scale may be reduced. Transport distance may also be longer – between the island of Ireland and the rest of the EU, rather than between Northern Ireland and Great Britain. 

The latest Eurostat data, which are for 2020, show that food retail prices were 34% higher in the Republic of Ireland than the UK average. Data for 2016 suggests we can assume that Northern Ireland is broadly the same as the UK average (ONS, 2018). Annual spend on food and non-alcoholic drink in Northern Ireland was £2.5 billion in 2020. 

A wide variety of factors – for example, higher wages and rents, or monopoly profits – might explain the higher food prices in Ireland. Some of this could be the result of differences between the two systems of logistics. And, if the Protocol leads to Northern Ireland-Republic of Ireland supply chains to a greater extent, this may result in higher retail prices. 

Take a possibly optimistic scenario. If eventually a quarter of the Northern Irish grocery market shifts to Republic of Ireland’s supply chains – and assuming that a quarter of the price difference (hence 8.5%) is linked to logistics differences – this would imply that the cost of food retail would rise by about £50 million (that is, 8.5% of a quarter of £2.5 billion). 

If, more pessimistically, we assume that eventually half of the Northern Irish grocery market shifts and that half of the price difference is attributable to logistics, then the cost impact would be about £200 million (that is, 17% of half of £2.5 billion).

Government is spending about £250 million annually in relation to the Protocol, mostly related to trying to reduce the cost to businesses. Some of this is information and online assistance (for example, the Trader Support Serviceand Movement Assistance Scheme). A relatively small part of the government spending funds veterinary checks at Belfast and other Northern Irish ports. 

It might be argued that most of this is really a cost to the UK exchequer and not to Northern Ireland specifically: very little is charged to the Northern Irish block of public spending. But a cost to the UK taxpayer is a cost to that taxpayer regardless of where it falls in the government accounts. 

At some point, the UK government is likely to scale back this spending and the burden will shift to businesses in Northern Ireland and Great Britain, or the regional government in Northern Ireland will have to take up the slack.

What is the economy-wide impact?

The analysis above has been limited to businesses, consumers and government separately. One study has estimated the impact on the overall Northern Irish economy (Duparc-Portier and Figus, 2021). Given the scale of purchases into Northern Ireland from Great Britain and the increase in the costs of these, the research suggests that even allowing for benefits such as continued free access to the single market, the long-run ‘cost’ to the economy is equivalent to 2-3% of GDP, although the impact of inward investment is not considered (discussed below). 

It might be objected that this estimate uses an unattainable counterfactual – what the situation would have been had the UK remained in the EU – but a response could be that the research analyses the variant of Brexit that was chosen. This turns out to have substantial net costs, most of which are attributable to increases in the cost of goods brought from Great Britain to Northern Ireland in terms of non-tariff barriers.

It is worth stressing that this work does not include spillover effects of any Brexit-related UK-wide reduction in GDP on Northern Ireland (Duparc-Portier and Figus, 2021). Hence, the results are not directly comparable with those of many of the forecasting exercises related to the impact of Brexit on the overall UK economy.

Protocol benefits: best of both worlds in trade?

As well as the reduction in supply resulting from higher costs, the Protocol can be thought of as acting as a protective barrier around the two Irish economies. It would therefore be unsurprising if trade between Northern Ireland and the rest of the UK dropped, while that between Northern Ireland and its southern neighbour increased – the phenomenon known as ‘trade diversion’, first identified by Jacob Viner (Lipsey, 1957).

The Republic of Ireland’s CSO data suggest this, although we do not yet have data on east-west trade flows. Compared with 2020, Northern Irish exports to the Republic of Ireland grew by 65% and exports going in the other direction grew by 54%. 

It is hard to reconcile such stellar value growth with data showing that the total number of border crossings by freight vehicles increased by only 12% in 2021. Some individual businesses in Northern Ireland have gained as British firms have sold less into either Northern Ireland or the Republic of Ireland. But as with trade protection, there remains the question about the overall impact on economic welfare of such trade diversion. The study discussed above emphasises that Northern Ireland will not get the ‘best of both worlds’ (Duparc-Portier and Figus, 2021)

Protocol benefits: more inward investment?

Northern Ireland is the only part of these islands with access to both the UK’s internal market and the EU’s single market for goods. Might mobile foreign direct investment projects in manufacturing now have incentives to come to Northern Ireland?

Data on foreign direct investment after 1 January 2021 are extremely limited. But we may draw some idea of any changes by looking at job announcements made by the development agency Invest NI. 

In 2020, 616 manufacturing jobs were announced (27% of the total) and 1,626 in services. Between 1 January 2021 and 15 March 2022, 508 jobs were announced in manufacturing (17% of the total) and 2,514 in services (including ASOS, PwC, Hinduja Global Solutions and KPMG). 

Job announcements do not necessarily translate into job creations. At least two major manufacturing businesses (Almac and AMP) made announcements in 2021, which were not reflected by Invest NI (1,000 jobs in the case of the former, 160 for the latter). For what they are worth, the Invest NI job announcements do not indicate a post-Protocol jump for investment in manufacturing.

Northern Ireland’s foreign direct investment performance should be put in context. For several decades now, its revealed competitive advantage has been in terms of services activities (for example, information technologies and back office work, especially originating from US firms). 

The Republic of Ireland, in contrast, relies much more on data centres and manufacturing plants. Given the Protocol’s emphasis on traffic in goods, it probably has much less impact (either positive or negative) on Northern Ireland’s attractiveness as a location for services. It remains to be seen how far we will see additional manufacturing activities come to the region.

Long-run impact of the Protocol: reduced policy discretion

The economist John Maynard Keynes famously said, ‘In the long run we are all dead’ – so what of the Protocol and the long run? 

Northern Ireland remains a rule-taker with respect to the EU and that is notwithstanding whatever may happen in terms of divergence between British and EU regulations. In these circumstances, there must be some doubt as to whether Northern Ireland will be able to benefit meaningfully from the following potential policy levers:

• Free trade agreements (FTAs): given continued compliance with EU SPS, it is hard to see how full participation in any FTAs will be possible. FTAs may require granting access to agricultural commodities produced at different standards.
• Freeports: the UK government is promoting freeports in Scotland, Wales and the English regions. The impact of any freeport depends crucially on the strength of its incentive package. Unless the EU is prepared to grant extreme forbearance in terms of Northern Ireland, it is unlikely that any Northern Irish freeport could involve a worthwhile incentive package.
• Tax rates: Northern Ireland must follow EU market rules, including case law established by the European Court of Justice. One implication of this is that if any Northern Irish tax rates are reduced compared with the UK average, then the UK government is obliged to reduce the block grant by an amount equivalent to the reduction in revenue collected. Of course, the Treasury could well be minded to reduce the block in such cases, but there is now no discretion. Some commentators, such as the Fiscal Commission, argue that it precisely such discretion that Northern Ireland should seek. 

What, if anything, might happen next?

The Protocol negotiations between the UK government and the EU continue with apparently glacial progress. It is probably now impossible for the UK government to make credible threats of a trade war over the Protocol given the real war in the Ukraine. Use of the Protocol’s Article 16 (a unilateral suspension) also seems unlikely.

Leaving aside the wider, political implications of the Protocol, the following policy options may exist:

• Reduce or remove the need for SPS/veterinary checks between Northern Ireland and Great Britain by the UK government agreeing a deep food standards agreement with the EU. This is unlikely, given that this would cut across the promotion of FTAs and the fact that the long-run approach to agricultural support policy in England remains very unclear.
• Trusted trade arrangements for businesses importing from Great Britain into Northern Ireland – these are more likely to apply to larger firms. 
• Mutual enforcement: both the UK and Republic of Ireland legislate to make it a requirement that exporting businesses comply with the regulatory standards of the other jurisdiction. This would not remove administrative costs, but checks would not occur at either the Irish land border or across the Irish Sea. Instead, there could be spot check inspection at point of sale in both jurisdictions, followed by exchange of information and then any enforcement.

The cost of living crisis and wider inflationary pressures during 2021-22 outweigh the cost disadvantages imposed by the Protocol. That said, Northern Ireland can do little about movements in global energy markets.

The Protocol represents policy choices that could conceivably be changed. The most likely scenario is that at the end of 2022, the Protocol will still be in place at its current, partial level of implementation. Economists can make the modest proposal that more and better data would help us to understand the position more clearly.

Where can I find out more?

• What impact will the Protocol have on the Northern Ireland economy? Graham Gudgin and Harry Western on the economic effects of the Protocol.

• How is Brexit affecting Northern Ireland’s economy? Esmond Birnie and Graham Brownlow examine the effect of Brexit on the Northern Irish economy.

Who are experts on this question?

• Graham Brownlow, Management School, Queen’s University Belfast
• Geoffroy Duparc-Portier, Fraser of Allander Institute
• Giole Figus, Fraser of Allander Institute
• Graham Gudgin, Honorary Research Associate Centre for Business Research at Cambridge Judge Business School
• Esmond Birnie, Senior Economist, Ulster University Business School

Author: Esmond Birnie

The post What has been the economic impact of the Northern Ireland Protocol? appeared first on Economics Observatory.

The response of many governments, most notably in Europe, the United States and other pro-Western countries, has been to impose a range of sanctions on Russia, as well as offers of military and political support to Ukraine. The European Union (EU) and the UK alone account for around 40% of Russia’s trade in goods and services.

The measures are likely to have a significant impact on Russia’s economy. The World Bank forecasts that on the basis of sanctions announced in March 2022, by the end of 2022, Russia’s GDP will be 11% lower, investment 17% lower, inflation will rise to 22%, and exports and imports will fall by 31% and 35% respectively (World Bank, 2022). In addition to this impact on the economy, there should be an effect on Russia’s war effort, not least because a large share of Russian imports is relatively technology-intensive.

But it is not just Russia that will be affected. Apart from the destructive effect of the war on Ukraine, there will be an impact on adjacent countries, especially in Europe. The flow of refugees will place a strain on welfare states in these countries. There will also be effects on trade. The EU, the UK and the United States have all placed restrictions on energy imports from Russia in response to the invasion. The ability of the EU, in particular, to diversify away from dependence on imports from Russia, notably of oil, gas and fertiliser, will take longer.

Of potentially greater long-run significance for Russia is the range of other measures adopted by these countries, including sanctions on financial services and on individuals who are perceived to be close to the Putin regime.

More generally, the Russian economy may suffer from the collapse of technical, scientific and cultural ties with the West. This could lead to a ‘brain drain’ of younger and more outward-looking Russians who do not wish to remain in a country that is rapidly becoming a pariah on the world stage.

Sanctions and trade wars

The imposition of sanctions on Russia is perhaps the most striking illustration of the recent reversal of policies designed to encourage greater trade between countries. These policies emerged following the establishment of a range of multilateral institutions after 1945 and, in particular, the General Agreement of Trade and Tariffs (GATT) in 1947 and its successor, the World Trade Organization (WTO), established in 1995.

The intention of the GATT/WTO was to minimise the threat of ‘trade wars’, whereby trade defence mechanisms such as tariffs, non-tariff barriers and embargoes are imposed for strategic political and economic motives. The desire to avoid trade wars led to measures designed to discourage both one-sided and ‘tit-for-tat’ trade restrictions, and the implementation of mechanisms designed to resolve trade disputes.

It was also implicitly hoped that greater trade co-operation between countries would lead to the liberalisation of political regimes and bring greater emphasis on human rights and individual freedoms. Increasingly in recent years, these hopes have been dashed.

Trade sanctions have been implemented over the years against smaller countries such as Rhodesia (now Zimbabwe) from the mid-1960s through to the 1970s and, more recently, Myanmar in 2021 (Losman, 1978; Poletti and Sicurelli, 2022). These measures have generally been perceived as rather ineffective due to the proximity of those countries to other countries that were prepared to ignore such embargoes and sanctions.

But more recently, the willingness of President Trump to institute trade wars with countries that he perceived to be engaged in ‘unfair’ trade practices against the United States – including China, the EU, the UK and indeed pretty much everyone else – points to the erosion of the mantra of ‘free trade’ as engineering the growth of world output. Indeed, it indicates a move towards more nationalist and protectionist economic policies among some major countries.

The use of trade restrictions against Russia for political reasons is arguably more morally justified – and universally supported – than explicitly protectionist policies. This has been reflected in popular support for the measures.

Social media has played a role in encouraging boycotts of individual firms operating in Russia, the boycott of Russian goods and services and the inclusion of individuals (and their families) on sanctions lists. For example, Nestlé was slow to pull out of Russia until social media called for boycotts of Kit Kats and Nespresso coffee pods (Blitz, 2022). The daughters of Putin and the step-daughter of Russia’s foreign minister Lavrov were called out on social media such as Twitter and Instagram for their lavish lifestyles in the West, and sanctions were placed on them by the UK and US governments.

What sanctions can be imposed and what are their legal implications?

Sanctions against Russia are subject to the rules and mechanisms designed by international institutions to limit protectionist policies. They are also bound by more basic principles of the rule of law, especially when it comes to sanctioning individuals.

A variety of measures have been taken against Russia since the invasion of Ukraine. These include:

• Sanctions against goods, services and finance in Russia.
• Sanctions against individual companies operating in Russia.
• Sanctions against specific individuals associated with Putin.
• Suspension of the ‘most favoured nation’ (MFN) clause in the WTO, which prevents countries from discriminating between their trading partners.

The use of these sanctions raises questions about how trade measures can be used in a political setting and what are the legal and economic consequences. The perceived weakness of the WTO in handling trade disputes has, for example, led the EU to take the lead in strengthening its own trade defence mechanisms, including a proposal for an ‘anti-coercion instrument’. This is a response to coercive tactics taken by third states to threaten or undermine EU policies. The anti-coercion instrument would allow the European Commission to take trade, investment or other restrictive measures towards a non-EU country exerting pressure (European Commission, 2021). The question is whether the events in Ukraine have eclipsed these mechanisms and safeguards.

The objectives of economic sanctions are often compared to the objectives of criminal justice:

• Do they deter bad behaviour?
• Can they be enforced?
• Are their punishments effective?
• Do they lead to changed behaviour by the targeted countries?

Sanctions against goods and services

In 2020, 44% of Russian exports were bound for NATO countries (40% to the EU and the UK, and 3% to the United States). In terms of imports to Russia, 38% come from NATO member states (35% from the EU and just over 4% from the United States).

Given that trade as a share of Russian GDP in recent years is close to 50%, wide-ranging trade sanctions could in principle have a significant effect on economic activity in Russia (Gasiorek and Larbalestier, 2022).

Russia relies heavily on imports for technology, finance, capital and consumer goods. For example, imports of machinery, parts and electrical equipment account for around a third of imports by value, and a large share of them comes from the EU. Further, pharmaceutical products account for only 5% of imports by value to Russia, but two-thirds of these come from the EU.

In due course, Russia may be able to diversify suppliers. Even in the short term, it may be able to obtain some necessary imports by indirect means, such as false invoices or smuggling. But while Russia has land borders with countries, such as Belarus, that are not implementing sanctions, there is unlikely to be scope for the kind of unchecked imports that allowed countries, such as Rhodesia, to evade sanctions in the past.

Economic sanctions against Russia will affect the global economy insofar as they cover exports of wheat, corn, sunflower oil, fertiliser, metals (nickel, copper and iron), neon, palladium (used in microchips) and platinum. Gas and oil are the main commodities where countries applying sanctions will be at their weakest.

Russia has long exploited gas and oil exports as a weapon of trade war in its disputes with Ukraine. Here the EU is vulnerable in the short run: it is estimated that after the winter, European supplies will be at 30% capacity. Within the EU, member states have wanted to keep control over their energy policy choice, especially the mix of energy and when national public interest may be used to divert from the four freedoms (goods, services, capital, establishment).

State aid and competition law may be used to challenge these choices, and indeed to encourage certain choices, for example, the development of green energy. But member states retain sovereignty. The lack of an integrated energy policy for the EU is the Achilles heel that Russia will continue to try to exploit.

Evidence from sanctions after the annexation of Crimea in 2014

There have been some attempts to estimate the impact of current economic sanctions on Russia by looking at the limited sanctions imposed after the 2014 annexation of Crimea. These included financial restrictions on capital for investment, freezing of financial assets, immigration sanctions on particular individuals, prohibitions on technology transfer and technical assistance, and highly targeted trade sanctions. In turn, Russia retaliated with some restrictions on exports of some food products.

Evidence from world trade data suggests that both import and export values fell after 2014 (see Figure 1). But it is important to note that Russian trade values were already on a downward trend before that time, reflecting the weakness of the world oil and gas market. Indeed, as illustrated in Figure 1, the oil price index is a very good predictor of the value of Russian trade.

Figure 1: Russian exports and imports by value and oil price index, 2005-2019

Source: United Nations (UN) International Trade Statistics Database. Note: the dark blue line (oil prices) is an indexed value, rather than a nominal value.

It is estimated that the trade restrictions implemented in 2014 resulted in no more than a 1% reduction in Russian GDP (Korhonen, 2019).

The most significant sanctions are thought to be those that restricted Russian companies’ access to foreign capital, since investors in the EU and the United States were barred from providing capital to five major Russian banks, as well as companies operating in the oil and gas, and military sectors (Korhonen, 2019). Another study also suggests that targeted companies performed significantly worse than other companies engaged in similar activities in Russia (Ahn and Ludema, 2019).

Cutting off external sources of financial support to Russian companies after 2014 had an impact on the viability of their activities. Investors in the EU, the UK and the United States were forbidden to provide financing beyond 30 days to several Russian state banks, oil companies and several firms operating in the military sector. This had two major effects:

• First, foreign investment in Russia fell as a consequence of these sanctions – by one estimate by $700 million per quarter(Korhonen and Koshinen, 2019).
• Second, the foreign debt of Russian banks held abroad fell from a peak of $214 billion to $74 billion in 2019, as these institutions switched to assets held domestically in roubles. The Russian economy has becoming increasingly dependent on capital generated internally, a process that will be exacerbated by the more wide-ranging sanctions introduced in 2022.

What were the legal ramifications of the annexation of Crimea and suspension of Russia’s MFN status?

A further response to Russian aggression in Crimea was the revocation of Russia’s MFN status from the EU, the United States and other G7 countries.

The MFN clause is the foundational principle of the GATT/WTO. It guarantees that each member of the WTO receives the same treatment: the lowest tariffs granted to one member should apply to all members. But there is an ‘essential security’ clause in Article XXI of the GATT, which can be used unilaterally to justify protectionist measures. Reacting to the Russian invasion of Ukraine in February 2022, Canada, the UK, the United States and several other WTO members revoked the MFN from Russia (Collins, 2022). The use of this clause has emerged before in the Russia-Ukraine context.

The political use of trade to sanction a breach of international law is understandably contentious. Resort to trade countermeasures for a breach of international law is seen as undermining the stability of the world trading system. Few disputes have been brought before WTO panels – indeed, the most notable was in relation to Russia’s annexation of Crimea in 2014. Another arose in 2019 when Qatar initiated consultations with Bahrain, Saudi Arabia and the United Arab Emirates concerning sanctions in relation to Qatar’s alleged funding of terrorism.

A WTO panel examined the essential security provision in the dispute brought by Ukraine against Russia after the annexation of Crimea by Russia in 2014. The illegal annexation led to the imposition of economic sanctions by various countries against Russian entities. Russia responded by imposing transit bans and other restrictions preventing the transit of goods from Ukraine to Kazakhstan and other bordering countries.

Ukraine brought a dispute to the WTO claiming this was a breach of the GATT. While Russia asserted that the measures were necessary for the protection of its essential security interests. Russia – backed by the United States – argued that the WTO panel lacked jurisdiction to evaluate its measures. The panel disagreed with this last point and found that it had jurisdiction to review Russia’s use of the essential security justification. But it also found that the situation between Ukraine and Russia since 2014 was an emergency in international relations, and that Russia’s measures had been taken during that emergency.

The panel concluded that every WTO member may define what it considers to be its essential security interests. This discretion is limited by an obligation to interpret and apply the essential security clause in good faith. This involves an obligation ‘to articulate the essential security interests … sufficiently enough to demonstrate their veracity’, and there should be a connection between the essential security interests invoked and the measures taken. Russia could determine the ‘necessity’ of the measures for the protection of its essential security interests.

The panel would not decide on the legality of Russia’s annexation of Crimea under international law. It ruled that it was ‘not relevant’ to its determination whether Russia had ‘any international responsibility for the existence of this situation to which Russia refers’. Russia objected to the panel’s reference to the ‘international community’s’ condemnation of the annexation of Crimea’, leading to the replacement of this term with ‘the UN Resolution’. This indicates the panel’s view of separating out liability under international law and liability under international economic law.

The legal implications of these events for the sanctions imposed on Russia in 2022 are unclear. It might be hard for the countries introducing sanctions – unlike Ukraine itself – to argue that their essential security interests have justified their actions against Russia without arguing that in some more general sense, Russia’s actions in Ukraine threatened a more global conflict.

On the other hand, given the world’s almost unanimous condemnation of the Russian invasion – and growing claims of war crimes committed in Ukraine – it would be ironic at best for Russia to attempt to pursue a dispute at the WTO, arguing that the suspension of the MFN clause was unjustified.

New financial sanctions

The financial sanctions introduced in 2022 are wide-ranging. First, the Russian central bank has been barred from using its ‘emergency reserves’ held in foreign central banks and commercial banks in the form of foreign exchange and securities. By freezing these assets, Russia’s ability to use its foreign exchange reserves to purchase goods and services abroad is severely limited.

In similar vein, the Russian sovereign wealth fund has been targeted and cannot sell assets abroad to finance purchase material. This has an immediate impact on the much-vaunted Russian ‘war chest’ of $600 billion (Cecchetti and Schoenholtz, 2022).

Since these sanctions are internationally co-ordinated and include countries that are normally reluctant to participate in actions of this kind – such as Switzerland – these are potentially powerful constraints on Russian economic activity. They are forcing the economy to rely largely on current receipts from its exports to finance foreign purchases.

Since Russia is running a trade surplus – and has imposed capital controls to limit outflows of foreign exchange through capital flight or purchase of non-essential imports – the immediate effect may be limited. But as countries currently importing from Russia find alternative sources of supply, the constraint on foreign exchange reserves will bite harder.

Russia has responded to the financial effects of these sanctions by demanding that foreign countries pay for their energy supplies in roubles. This could be difficult to enforce, especially since the assets of the Russian central bank abroad are frozen and contracts would have to be legally re-negotiated for changes to occur.

Even if this could happen so that foreign purchasers of Russian oil and gas have to convert their currencies into roubles via the remaining parts of the Russian banking system that are not sanctioned, it is hard to see that this threat is anything other than symbolic.

Russia could try to enforce some sort of multiple exchange rate system by which roubles must be purchased at an artificially high rate, but it is not clear how this would work. Such exchange rate regimes typically collapse or lead to the development of increasingly overt black markets where the local currency is purchased at a cost well below the official rate.

There are also sanctions against Russian commercial banks. SWIFT (the acronym for the Society for Worldwide Interbank Financial Telecommunication) is a messaging system that allows banks around the globe to communicate quickly and securely about cross-border payments. It is a member-owned co-operative based in Belgium, made up of global banks. On 2 March, SWIFT announced that it would cut off seven Russian and three Belarusian banks from its system with effect from 12 March.

The consensus is that this measure will have a limited effect. First, because several Russian banks are not sanctioned; and second, because there are other, albeit more costly, means of communicating bank transactions other than through SWIFT (House of Commons Treasury Committee, 2022).

In similar vein to those imposed on Russia’s central bank, several countries have imposed sanctions on other Russian banks such as Sberbank, VTB Bank, Alfa-bank, Bank Otkritie and Rossiya Bank. Again, this involves freezing assets held abroad and a ban on any bank dealings in these markets.

Other companies and entities, as in the post-2014 sanctions, are limited in the activities that they can undertake abroad – whether purchases (for example, in the case of defence and technology state-owned companies) or raising capital (in the case of oil and gas companies such as Gazprom).

Critics have pointed to the fact that several Russian state-run and commercial banks continue to operate relatively free of sanctions. As the war continues, there will be pressure to widen the reach of the sanctions, but while Russia continues to export products such as oil and gas, it is inevitable that some means of trading with Russia will continue.

The effects of asset freezes on banks on domestic Russian activity is harder to calibrate. Research suggests that after the post-2014 episode, sanctioned Russian banks adjusted their asset and liability structures, moving away from foreign assets and liabilities into the domestic market (Mamonova et al, 2021). They may therefore be more protected from the current sanctions.

Since the Russian central bank can presumably still provide liquidity to the domestic banking system, the Russian financial system is likely to survive, albeit in an increasingly autarkic economic system.

Sanctions against specific individuals

Russian oligarchs or billionaires considered close to Putin were quickly targeted by the EU, the UK and the United States. The personal and corporate assets of these individuals have been frozen and they have also been denied access to maintenance of assets and hiring employees.

Calls for these sanctions have been made since the annexation of Crimea in 2014, justified by arguments that these oligarchs fund major infrastructure projects in Russia, such as the Sochi Olympics or the bridge to Crimea. Crucially, they also fund personal projects for Putin, such as his villa on the Black Sea and private yachts (European Council, 2022).

The oligarchs deny that they have political influence over Putin and that such sanctions are not justified. But do they have any legal recourse in such a case?

After sanctions were imposed following the 9/11 attacks, the EU agreed guidelines on the use of sanctions. Under these, individuals and firms may resort to legal challenges to the sanctions using domestic law – and in the EU with recourse to EU courts, either directly or through the preliminary reference procedure.

EU law provides procedural safeguards, alongside guarantees of adherence to fundamental rights found in EU law, but the EU courts will not interfere in the merits of the case. An attempt by Rosneft – a Russian energy company, 69% of which is owned by the Russian state – to have the underlying EU Regulations annulled when sanctions were imposed on it after the annexation of Crimea was dismissed by the Court of Justice of the European Union (CJEU) in 2017. The Court found that there was a reasonable relationship between the sanctions and the objectives underpinning them:

‘… in so far as that objective is, inter alia, to increase the costs to be borne by the Russian Federation for its actions to undermine Ukraine’s territorial integrity, sovereignty and independence, the approach of targeting a major player in the oil sector, which is moreover predominantly owned by the Russian State, is consistent with that objective and cannot, in any event, be considered to be manifestly inappropriate with respect to the objective pursued’.

Conclusion

The world has responded to the war in Ukraine in an unprecedented way: by using economic sanctions and defensive trade instruments to show political opposition to the Russian invasion. In particular, financial sanctions against Russian banks and other state agencies have had a dramatic impact on Russia’s ability to use foreign exchange and credit lines to bolster its war effort.

This makes the Russian economy more dependent on current revenue flows from its exports of oil, gas and related products. Cutting usage of such products, especially by EU countries, remains a priority. But as Figure 1 shows, any fall in the price of oil will have an adverse effect on Russia’s foreign exchange revenues. Measures to enhance supplies of oil and gas from other producers are therefore a priority, thereby raising total supply while simultaneously allowing countries to divert demand to other producers.

On the legal side, time will tell if the response can have political leverage and force Russia to withdraw from Ukrainian territory. For example, one question, both legal and economic, remains unanswered: how long should the sanctions and revocation of the MFN last, and can Russia successfully appeal any of the dramatic legal and administrative measures taken against it?

A cessation of military activity and withdrawal from Ukrainian territory seems an essential prerequisite before these questions can be answered – and this will only be the first step in what could be protracted negotiations over the future security of Ukraine.

Where can I find out more?

• EU sanctions map: An interactive map showing UN and EU sanctions affecting 33 countries.
• Russia's war on Ukraine: A sanctions timeline.
• Russian sanctions: Some questions and answers: VoxEU article.
• The WTO’s first ruling on national security: What does it mean for the United States? Center for Strategic and International Studies.
• The WTO’s essential security exception and revocation of Russia’s Most Favoured Nation status following the invasion of Ukraine: Article for the City Law Forum by David Collins.
• Kadi and Al Barakaat v. Council of the EU & EC Commission: European Court of Justice quashes a Council of the EU Regulation implementing UN Security Council Resolutions, American Society of International Law.
• The Kadi case – constitutional core values and international law – finding the balance? Article in the European Journal of International Law.
• Ukraine: UK Trade Policy Observatory.
• The Ukraine-Russia crisis and possible trade sanctions: UK Trade Policy Observatory.

Who are experts on this question?

• Stephen Cecchetti
• Adam Cygan
• Richard Disney
• Erkal Ersoy
• Sergei Guriev
• Ben Moll
• Kim Schoenholtz
• Erika Szyszczak

Authors: Adam Cygan, Richard Disney and Erika Szyszczak

Note: An earlier version of some of this material was discussed in a seminar on 29 March 2022 involving some of the authors and participants from the Universities of Kyiv and Lviv.

Photo by Lidia Mukhamadeeva on iStock

The post Sanctions on Russia: what are the ramifications of this new trade war? appeared first on Economics Observatory.

War always results in deaths, destruction and forced displacement. As of 20 March 2022, 977 verified civilian deaths have been recorded, with 1,459 reportedly injured (UN Office of the High Commissioner for Human Rights, OHCHR, 2022). More than three million Ukrainians (about 4.5% of its population) have fled to safety in other countries (OHCHR, 2022). It is difficult to verify these numbers, and many commentators fear the toll could be far higher. Nevertheless, this substantial shock to the local population is likely to have an adverse effect on the country’s capacity to produce and export food products.

In response, severe economic sanctions have been levied on Russia in a bid to end the war. Potential Russian responses to the sanctions could also have a negative effect on global food supplies.

How is the war affecting food production?

Russia and Ukraine – together sometimes called the ‘breadbasket of Europe’ – are top producers and exporters of several important grains (such as wheat and maize) and vegetable oils (see Table 1).

Table 1: Ranking of world production of major food crops (2020)

Source: World Integrated Trade Solution, WITS (2022)

Figure 1: Share of total world exports for major food-related commodities (2020)

Source: WITS (2022)

Ukraine is the world’s largest producer of sunflower oil and, combined with Russia, it is responsible for more than half of global exports of sunflower oil (Figure 1). The region is also responsible for over a third (36%) of wheat exports (making it the world’s largest exporter of wheat).

Nearly every continent depends on them for either sunflower oil or wheat. In 2018, the European Union (EU) and other European countries were among the top importers of Russian and Ukrainian sunflower oil, with Southeast Asia and the Middle East the largest importers of the region’s wheat (Figure 2).

Instability in the region is therefore likely to affect food supply in the importing countries, many of which are currently food-insufficient – a situation where there is not enough food to eat.

Figure 2: Importers of Russian and Ukrainian sunflower oil and wheat (2018)

Source: WITS (2022)

The Russian invasion has resulted in the suspension of commercial operations in Ukraine’s ports, hampering the country’s ability to export its products. A halt in agricultural exports is bad for Ukraine as agriculture is a major source of its export revenue – 45% in 2020, amounting to $22.2 billion (International Trade Administration, ITA, 2022).

At the time of writing, there are still a few weeks left before the spring planting season in Ukraine. But with intense fighting continuing, and farms either shut down or occupied by Russian soldiers, future food output is very likely to be jeopardised. Former Ukrainian agriculture minister Roman Leshchenko has said that the country’s spring crop sowing area could be less than half what it was in 2021 (Reuters, 2022).

Farmers may be incentivised to ‘eat their seed’. Many other producers have fled the war to neighbouring countries for their own safety. Whether the displaced population will restore balance in global food supply by going into farming in their host nations is questionable, certainly in the short term. Others that remain in the country are presumably fighting or supporting the war effort.

The Irish government has launched a €12 million crop growing scheme to boost planting of barley, wheat and oats to help make up the drop in production in Ukraine. But many farmers have said that the incentive payments are too small to ‘counter the surging cost of fertiliser and fuel’ (Financial Times, 2022).

In addition to the effects on the population, and therefore workforce, the destruction of farms and storage facilities, and the transformation of tractors into armoured vehicles, are all contributing to a reduction in food production (Bloomberg, 2020). In times of war, farmers also reduce the time they spend on the farm for security reasons (for example, in response to an imposed curfew).

Reduction of food production in Ukraine translates into low or no exports. Ukrainians may start hoarding food for survival, or even seek to profiteer from the situation.

Russia could also retaliate in response to the severe economic sanctions placed on it, by restricting food supplies (as in 2010, when Putin placed a ban on exports of grain following a severe drought that hit the country).

Overall, the war affects food supply everywhere – in the conflict zones as a result of a fall in food production, and the rest of the world due to a drop in the export of major staple food commodities.

How is the war affecting the prices of food, fuel and fertiliser?

Scarcity of food has led to rising prices within the conflict zone and elsewhere in the world. Both local and global markets are stressed because food demand is high while supply has been restricted (and is becoming increasingly expensive). Rising food prices mean rising food insecurity.

Food prices have been rising since January. The Food and Agriculture Organization (FAO) of the United Nations reports that the food price index is 24.1% higher than it was a year ago, and similar trends have been experienced across the world (FAO, 2022). In the UK, for example, food price inflation hit 4.3% in February 2022, the highest in about a decade (Office for National Statistics, ONS, 2022).

In Ukraine, household income has fallen while poverty is rising. This is due to deaths of household heads (such as parents), job losses following destruction of infrastructure and businesses, and reduced economic activities. Forced migration to countries still grappling with post-pandemic recovery has also contributed to the crisis. Loss of income makes it more difficult for Ukrainians to access food, especially against the backdrop of rising prices.

In other parts of the world, rising food prices reduce the real incomes of households, pushing more people into the food poverty trap. This effect is graver in developing regions, where a larger part of people’s disposal income is spent on food. For example, a further rise in food prices would be more severe for an average household in Nigeria, which spends 56.4% of its income on food, compared with an average household in the UK, whose share of food expenditure is only 8.2% of their income (see Figure 3).

Figure 3: Share of income spent on food

Panel A – highest share

Panel B – lowest share

Source: ERS, United States Department of Agriculture (2015)

Russia is the third largest petroleum and liquid fuels producer in the world, after the United States and Saudi Arabia. It is the second largest exporter of crude oil after Saudi Arabia (see Table 1 and Figure 1). Russia is also a major fertiliser producer and exporter.

Sanctions on Russian oil companies and the planned ban on Russian oil have triggered an increase in fuel prices in the international market. The price of Brent crude for delivery on 21 March 2022 stood at $122 per barrel – the highest since 2015. Although oil-exporting nations like Saudi Arabia and Qatar will benefit from this price rise, oil-importing nations will feel the brunt as import bills are set to rise.

Figure 4: Daily Brent front-month futures contract price (2014-2022)

Source: Energy Information Administration (2022)

Note: The blue line illustrates the $100 per barrel mark

The movements fuel and food prices are closely linked (Karel and Krištoufek, 2019; Debdatta and Mitra, 2017). Even countries that are self-sufficient in grain production, such as the UK (which produces 90% of wheat consumed locally), could be affected by the knock-on effect of rising fertiliser and fuel prices. Eventually, the burden of a higher cost of food production, storage and transport is passed on to the consumers through higher food prices.

Will the conflict change what people eat?

Falling food supply coupled with rising food prices and with reduced real incomes will make it difficult for people to enjoy a nutritious diet in many countries. There may be a shift in consumption patterns towards cheaper food substitutes, such as cassava. Besides other global factors, such as rising fuel and fertiliser prices, an increase in demand for these substitutes could also see their prices rise, depending on the degree of substitutability.

Whether such a shift will be temporary or permanent depends on a host of factors such as expectations about the duration of the war or the possibility of a global food price contagion. For example, households might decide to continue consuming wheat, despite the price rise if they expect that the conflict will end soon and the price of wheat will revert to its pre-war level.

Could the food crisis generate further conflict?

As a conflict intensifies, food can become even more scarce. This means the few remaining food stocks become increasingly expensive or insufficient (especially if rationed by the government). Either way, food becomes difficult to access.

This situation, where many hands are pursuing very scarce and expensive food resources, could incite civil conflict – as witnessed during the Arab spring, an event partly a reaction to high cereal prices. In the besieged Ukrainian city of Mariupol, reports have emerged of people attacking one another in desperation for food (Business Insider, 2022).

This ‘fight-food-fight’ narrative has been established in many economic studies, and implies that conflicts can arise as a result of struggles over limited resources such as land, food or people (Collier and Hoeffler, 2005; Harari and Ferrara, 2018). This vicious conflict cycle continues unless there is an external intervention in form of financial and food aid, or if the conflict in question comes to an end (which is the most effective).

What we do not know

War is costly. Beyond the present destruction and devastation, the process of reconciliation, rehabilitation and reconstruction post-war is very expensive.

Figure 4: Global growth projections (October 2021)

Source: International Monetary Fund (2021)

Whether the economic crisis is due to war, the changing climate or Covid-19, the consequences for global food supply are similar – low supply and high prices. But unlike with the pandemic, where most economies around the world bounced back quickly as projected by the IMF (Figure 4), we do not know how long it will take for food supplies to recover to their pre-conflict state. It will depend on several factors: the extent of the devastation, the effectiveness of foreign interventions and aid, and how quickly Ukrainian farmers can be trained and deployed to farms.

The long-term impact of low food imports is not yet clear. In the past, it has been suggested that low imports can make reliant nations look inward and strive towards greater food self-sufficiency (The Guardian, 2020). But whatever happens in the long run, what we know is that in the short term, local food production will not be able to compensate for lower imports, worsening food scarcity and insecurity as a result.

What way forward?

Global food supply has been affected directly and indirectly. It has been hit directly by shortages in food production, import restrictions, higher food bills and falling incomes – and indirectly by fuel and fertiliser price inflation. Acute hunger may motivate farmers to eat what they were previously planning to cultivate, which could reduce the next season’s planting capacity. Even where local farmers in developing countries seem to benefit from rising international food prices, such gains are eroded by falling real incomes.

There is an urgent need for an aggressive external intervention to avert a food crisis. Information sharing among countries about their food status, as well as keeping borders open for agricultural exports, as proposed by the G7 agriculture ministers, are important responses to the brewing food crisis.

Beyond providing ammunition and other supplies for Ukraine’s war effort, and financial aid for the ailing populace, it may make sense to send in farmers to help to revamp the agricultural sector in Ukraine, once the fighting subsides. But when it will be safe to do so remains highly uncertain.

Where can I find out more?

• The International Food Policy Research Institute blog gives an insight into the economic impacts of the Russian invasion on global food systems.
• The IMF blog details how the war in Ukraine is affecting different sectors in several parts of the world.
• A series of podcasts from The Economist discuss the several channels through which the war in Ukraine will affect global food supply.

Who are experts on this question?

• Sascha O. Becker
• Lotanna Emediegwu
• Erkal Ersoy
• Wandile Sihlobo
• David Ubilava
• Alfons Weersink

Author: Lotanna Emediegwu

Picture by ErgBob on iStock

The post How is the war in Ukraine affecting global food security? appeared first on Economics Observatory.

Yesterday, the world woke up to the news of war in Europe, with Vladimir Putin announcing a ‘special military operation’ in Ukraine’s Donbas region, just before 6am Moscow time. Although tensions have been mounting steadily over the past few weeks, confirmation of the invasion is nonetheless shocking.

Listening to BBC Radio 4’s Today programme early on Thursday morning, one of the stories broadcast from Kyiv was a report on panic buying. Already, people living in the capital were flocking to supermarkets, fuel stations, and – most disturbingly – firearms shops. Global or geopolitical events do have severe economic implications for people on the ground. In Ukraine, food, petrol and ammunition have never been in higher demand.

But the economic consequences of the Russian invasion go far beyond the shopfronts of Kyiv, Donetsk and Luhansk. Earlier this week, a range of international sanctions were levied against the Kremlin, including Germany announcing the suspension of the Nord Stream 2. The undersea pipeline – which was due to run gas from Vyborg in Northwest Russia to Lubmin just north of Berlin – offered a literal and symbolic connection between Russia and the West: a means for trade and energy supply, a channel of cooperation. But this economic tie has, at least for now, been severed.

The macroeconomy has been affected too. As the first missiles struck during the early hours of Thursday morning, the Russian rouble tumbled and oil prices spiked, climbing to over $100 per barrel for the first time since 2014. Simultaneously, global stock markets fell.

Eastern Europe has experienced extreme economic turmoil because of geopolitical shifts before. As recently as the early 1990s, hyperinflation in Yugoslavia reached 313,000,000%, which meant that prices were doubling every 34 hours. Economic instability was closely associated with the country’s disintegration – and the series of wars that followed brought widespread and long-lasting suffering for an entire generation of people. As similar events unfold in Ukraine, we sincerely hope the personal and economic costs are not too great.

At a time when international law is once again being broken, several articles posted on the Economics Observatory website this week stress the importance of rules in the face of big policy challenges. They argue that decision-makers should be guided by frameworks informed by sound economic thinking. Climate change, Covid-19 and Scottish independence are all issues that require expert guidance, and the right rules at the right time will be critical to navigating these uncertain waters.

Tightening business regulation

On Tuesday, we posted a piece by Michelle Kilfoyle on the likely effects of mandatory corporate reporting on sustainability. She argues that making firms become more transparent in their reporting has the potential to deliver social, environmental and financial rewards. But mandatory reporting is not a panacea. Rather, its success rests on carefully considered standards and the credible (and costly) enforcement of these rules.

According to data collected by accountancy giant KPMG, in 2020, 96% of the world’s largest 250 companies and 80% of large firms worldwide reported on their sustainability performance. Yet far more still needs to be done if we are to combat climate change. It is one thing to make businesses declare their environmental and social impacts, but another challenge to ensure that they then curb their harmful behaviour.

Michelle highlights that a key factor in achieving this is promoting competition. With more public information available on what other businesses are doing in the name of sustainability, compulsory corporate social responsibility reporting could foster competition between firms, as well as helping them to learn from one another.

There is already evidence that this works. In 2010, the United States made emissions reporting mandatory for thousands of factories. In response, these facilities reduced their greenhouse emissions by 7.9%. While the rules did not directly control company behaviour, the increase in transparency put pressure on polluters to clean up their operations for fear of falling behind their peers.

In strictness and in health

Perhaps the most high-profile rules over the last two years have been the Covid-19 restrictions. Since March 2020, people across the UK have lived under varying degrees of regulation. From stay-at-home orders to social distancing, not since the Second World War has everyday life been so closely bound by policy.

Protecting health has come at a cost. The measures introduced to curb the spread of the virus have had substantial negative effects of the economy – effects that are still being felt today. On Wednesday, Stuart McIntyre (University of Strathclyde) explored the latest regional GDP data from the Office for National Statistics (ONS), which cover economic activity across the UK up to the end of the second quarter of 2021.

These data highlight how different parts of the country are still experiencing a range of challenges, even as the worst of the pandemic appears to be behind us.

Figure 1: Q2 2021 levels of activity relative to 2019, by region and industry (100 = back at 2019 levels of activity)

Source: Office for National Statistics (ONS)

Figure 1 shows the change in economic activity in each region and nation relative to 2019. The data show that activity associated with hotels, restaurants and cafes was still only around 60% of its 2019 level in the second quarter of 2021. At the same time, in most other parts of the country, similar activity was closer to 80% of its 2019 level. Just as rules and restrictions have varied across the UK at different stages, so have the effects.

What the data show most clearly is that the rules introduced to protect public health have left the UK economy with a number of scars. While not all the regional and sectoral struggles can be attributed directly to lockdown measures, the latest GDP data provide a striking picture of the pandemic’s long-run consequences.

Winds of change

On Thursday, we published an article by Andrew Cumbers (University of Glasgow), Sheila Dow (University of Stirling/University of Victoria, Canada) and Robert McMaster (University of Glasgow) examining the political economy perspectives of Scotland’s future. The authors argue that while the economics of Scottish independence are important, they must be viewed as just one part of a process that will change the whole country. The economic concerns surrounding Scotland’s future should stand alongside concerns with social and moral priorities.

The referendums on Scottish independence in 2014 and on Brexit in 2016 presented problems for mainstream economics. The mistake, they said, was to assume that institutional relationships were fixed. The whole point of any possible constitutional change is that institutional relationships also change. In terms of the Union, the contents of the rulebook have been cast into doubt.

What now?

The concluding section of Thursday’s article helps bring us back to where we started. Andrew, Sheila and Robert argue that the economic debate concerning independence needs to be viewed as part of a process that will change institutions, governance, power relations and behaviour. Each of these changes, in turn, will have substantial economic consequences.

Many of the profound political and social changes of recent history have often happened against the consensus of economic thinking at the time. While the threat of further Russian aggression has been looming since 2014, the arrival of war in Europe is deeply unsettling. For many people the economic ties between Russia and the West should have been too strong, market forces too potent and stability too profitable. But this consensus view appears to have come undone. How the war will go on to affect people’s personal, political and economic security around the world remains to be seen.

Author: Charlie Meyrick

Picture by mrakor on iStock

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