Winter Is Coming: The Ukraine Shock

Carlos A. Primo Braga¹

This year will be remembered as the end of an era. Of course, the deaths of Queen Elizabeth II and Jean-Luc Godard come to mind, but what I want to emphasize are the implications of the war in Ukraine for the stability of the global economy. For the first time, since the Cuban Missile Crisis (1962), the specter of a nuclear confrontation between military superpowers is a serious threat. The economic externalities of the conflict are occurring in parallel with significant changes in monetary regimes around the world to fight inflation.

Putin’s description of the “special military operation” in Ukraine relied on misinformation from the very beginning. According to the Russian news agency Tass (March 4, 2022), the objectives of the intervention were the demilitarization and “denazification” of Ukraine. Moreover, Russian propaganda explicitly argued that Russian forces would not be attacking cities, that the civilian population was not in danger and that Russia had no plans for occupation of Ukrainian territories. The reality of the first seven months of the war, as illustrated by the destruction of Mariupol and the mass graves in Bucha and Izium, as well as the recent Donbass referendums, clearly contradicts this initial narrative.

The Russian strategy has been characterized by many failures. The idea of a rapid advance from the north, that would culminate with the collapse of the Zelensky administration proved to be a huge miscalculation and made explicit the logistic limitations of the Russian army. The reorientation of the Russian focus to the Donbass region happened in parallel with the adoption of a tactic of scorched earth without attention to civilian casualties. Progress, however, has been below expectations – e.g., the proposition that the Russian advances could lead to the control of the entire Black Sea coastline, all the way to the frontier with Moldova -- and the Ukrainian counteroffensives in the south (around Kherson) and in the northeast (around Kharkiv) illustrate the difficulties faced by Russia.

Recent developments, including the decision to draft up to 300,000 military reservists to fight in Ukraine and Putin’s reference to the use of nuclear weapons, suggest that the Kremlin is prepared to engage in a war of attrition and to use nuclear blackmail to limit Western military support to Ukraine.

There is, however, an even more immediate threat to the Western alliance. Winter is coming (and this observation is not a way to attract die-hard fans of the Game of Thrones series to read this piece...) in the Northern Hemisphere and this will be a key test of the resilience of the Western alliance against the Russian invasion. The impact of the war on energy prices – particularly, natural gas -- as well as on the availability of oil and gas exports from Russia to Europe are critical variables in this context. The manipulation of energy exports has been a tactic used by Russia since 2014 in the aftermath of the annexation of Crimea.

Western sanctions have imposed costs to Russia, but the reality is that as long as Russia can find other outlets (Turkey, China, India...) for its exports, the economic impact of the sanctions is limited. Moreover, the Russian policy is imposing significant costs upon the European economies – wholesale prices for gas and electricity have increased up to fifteen times in some markets compared to 2021². The European Commission (EC) proposal emphasizing measures that will stimulate demand reduction for both electricity and gas, while protecting vulnerable consumers, is a step in the right direction, but not enough³. After all, the Kremlin seems to be weaponizing its energy policy to a new level as illustrated by the sabotage of the Nord Stream pipelines in the last week of September.

It is true that Western countries are careful at not pointing fingers to Moscow at this stage. Not surprisingly, Russian TV is blaming the CIA for the three explosions severing the main gas connections to Europe. The prevailing theory, however, is that such an action would be of particular interest to Russia as it would be consistent with the current tactic of shifting energy exports to Asia, while spooking markets in Europe and fostering disharmony among Western allies. As prices of natural gas remain elevated, the arrival of winter – that typically implies average temperatures below 10 degrees Celsius -- is expected to create additional energy demand (and the specter of energy rationing). Russia believes that the military and economic support to Ukraine will become increasingly unpopular and high energy prices will foster dissension in the European Union between countries that have the fiscal space to address the problem (e.g., Germany) and those that need a coherent European response and budgetary support (e.g., Italy) to confront the crisis.

On September 30th, Vladmir Putin organized an event in Moscow to announce that the results of the referendums confirmed that the citizens of the republics of Donetsk and Luhansk, as well as those in the regions of Zaporizhzhia and Kherson, had “unequivocally” voted to join the Russian Federation. In this context, Russia would be annexing 15% of the Ukrainian territory. There is a saying, attributed to Mark Twain, that “history doesn’t repeat itself but it often rhymes.” Eighty-four years ago (September 30, 1938) the Munich Agreement was imposed upon Czechoslovakia as Germany, the United Kingdom, France and Italy agreed on the cession of the Sudeten territory to Germany. This was initially welcomed in France and the UK as a concession that would avoid war. What came next was proof of the dangers of appeasement to an aggressive military power.

Writing in 2015⁴, after the Russian annexation of Crimea I argued that the West had the following options: either adopt a strategy of deterrence (i.e., to provide robust military support to Ukraine), or a strategy of appeasement focusing on a combination of limited economic sanctions and a credible commitment to the neutrality of Ukraine. The calculation at that time, reflecting a game-theoretical approach, was that the West would be better off by adopting appeasement rather than by embarking on a full-fledged deterrence approach. I noted, however, that this game-theoretical approach was more an art than a science and that the calculation could change depending on Moscow’s next steps.

As George Mikes once said: “many continentals think life is a game; the English think cricket is a game”. But Putin seems to be playing by different rules and his game is even more complex than cricket. The current option in favor of deterrence is the correct approach, but it requires cohesion in the Western alliance. Moreover, for Ukraine to accept Putin’s proposal to get back to the table of negotiations, with the proviso that the Russian land grab is not open to negotiations, is a non-starter.

Putin’s speech on September 30th increased the concern in the West that the option to use nuclear weapons in the current conflict is a real possibility. Gone are the days when the Reagan-Gorbachev formulation was considered a consensus proposition (i.e., that a nuclear war could not be won and should never be fought). A public version of the Russian nuclear doctrine dated of 2014 states that:

“The Russian Federation reserves the right to use nuclear weapons in response to an attack on Russia and/or its allies involving the use of nuclear weapons or other weapons of mass destruction as well as in the case of aggression against the Russian Federation with the use of conventional weapons when the existence of the state itself is threatened. Decisions regarding the use of nuclear weapons are made by the President of the Russian Federation.”⁵

The current situation suggests that to the extent that the new territories annexed by Russia could be regained by Ukraine with Western support, this could be characterized as an aggression to the territorial integrity of the Russian Federation, potentially opening the door for the use of nuclear weapons. Many analysts argue that the likelihood of such a scenario remains low. Moreover, in the immediate future Russia will be evaluating the impact of its partial mobilization on the results in the front before adopting a nuclear “alternative.” If, however, the winds of war blow against Russia’s objectives, some believe that Putin would be willing to take the risk of using tactical nuclear weapons in Ukraine.

The bottom-line is that 2023 will be characterized by even higher levels of uncertainty at global level. Firms will have to further invest in resilience against geopolitical risk, adapting not only their business models, but also increasing their attention to investments in technology and productivity in a world that will become more fragmented and risky.

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