Editors' note: This column is part of the Vox debate on the economic consequences of war.
Russia is a major exporter of energy to the world, including the West. From the first days of Russia’s invasion of Ukraine, it has been said that by paying a billion euros a day to Russia (Fortune 2022), Western economies are effectively paying for Putin’s war (The Guardian 2022). There were immediate calls for a Western embargo on Russian energy, despite the wrenching adjustments that this would require (European Parliament 2022). After difficult negotiations the path to an EU embargo has now been agreed, but with an opt-out for Hungary (Financial Times 2022).
Who stands to lose more by stopping Russia’s energy exports? When Putin’s war is grinding on far longer than anyone anticipated, the argument that it is paid for out of Russia’s export revenues suggests that Russia must be desperate to keep its place in the world energy market. Meanwhile, most Western powers are working hard towards an embargo on Russia’s exports. They are also expending considerable political capital on efforts to bring backsliders into line, notably Hungary.
Yet Russia itself does not seem so desperate. Rather, the Russian government has set obscure financial conditions for Western buyers, such as payment in rubles (The Brussels Times 2022), and has already halted gas supplies to Poland, Bulgaria, and Finland (BBC News 2022).
It seems that both sides are treating Russian exports as their own weapon. While NATO threatens Russia with a stop on purchases, Russia threatens NATO with a stop on sales.
If you find this confusing, then you’ve been paying attention. Too many Western commentators have fallen victim to an old mercantilist error – that the strength of an economy is measured by its ability to attract gold from others through its export trade.
What are the underlying facts?
First, Russia has a large and growing export surplus. The Economist (2022) puts last year’s trade surplus at 7.5$ of Russia’s GDP. This year, it is expected to rise to 15% of last year’s GDP (this year’s GDP will be smaller by an unknown amount, perhaps 10% or 20%, pushing the share of the trade surplus still higher).
The reason for Russia’s growing export surplus is that, while exports are holding up, imports from a broad sample of Russia’s trading partners are collapsing – running at half the level of before the war’s outbreak. Why? There are two possibilities. One is that Western sanctions on Russia’s imports are working. The other is capital flight – holders of ruble balances are converting them into Western currencies, causing the ruble exchange rate to decline sharply and pushing up import prices for Russian consumers. In the short run, it does not matter which.
An expert quoted in The Economist finds Russia’s growing trade surplus “disappointing”. Although sanctions on Russia’s imports may be working, it seems we are still buying Russian energy exports at levels similar to before. We are still ‘paying for Putin’s war’ – or so it is said.
To understand what Russia’s growing trade surplus really means, it is necessary to recall that the money flows are the counterpart of flows of real resources. As money flows into Russian hands, real resources flow the other way. If Russia’s trade surplus will be 15% (or more) of its GDP this year, then in terms of the real resources produced, Russia is sending the same proportion of its domestic product abroad to be utilised by foreigners.
How does that matter for financing Putin’s war? It is often said that GDP is a measure of a country’s capacity to fight a war, and this is correct – approximately. But when the shooting begins, wars are not fought with GDP. They are fought using the real resources available. For this purpose, exports are not available. What is available is domestic production not exported, plus imports.
The national accounting concept of the resources available to a country at war is not GDP but ‘domestic absorption’ – the total of domestic expenditure, including expenditure on net imports.
With percentage points of last year’s GDP as the units, Russia’s trade surplus of 7.5 units left 92.5 for domestic absorption. This year, absorption will fall by the fall in GDP (say 20) plus the increase in the trade surplus (7.5), so 27.5. A GDP decline of one fifth becomes an absorption decline of one third.
Two things follow. One, the fact that Russia is exporting one seventh of its national income to the rest of the world is weakening, not strengthening, its war effort. Two, Russia’s exports are not ‘paying for Putin’s war’. They are certainly paying for something, but not that. What they are paying for is the accumulation of idle balances of foreign currency. This currency may be held by the state (within Russia) or by private citizens abroad (in the case of capital flight). But, if they cannot be used to import resources into Russia, they are not paying for Putin’s war.
A reality check is available. In two World Wars, the Allies blockaded Germany to prevent the import – not export – of resources. In both wars, Germany responded by confiscating resources from the countries it occupied, just as Russia today is accused of stealing grain and other valuables from Ukraine. In fact, in WWII Germany’s plan of overland occupation of the Eastern territories was designed in the expectation of an Allied blockade of German overseas trade. It has been calculated that net imports from Germany’s wartime empire paid for more than one quarter of Germany’s war effort (Klemann 2019). Net imports, not net exports!
These calculations concern only the volume of resources. The quality of resources matters too. Despite attempts at import substitution, Russia remains dependent on a wide range of imported microchips and machine and vehicle components and maintenance services (Shagina 2020). Russia needs these now to re-arm after its early military equipment losses. Using an energy embargo to stop Russia from getting them is like pushing on a piece of string. The more direct way, which is already working, is to sanction Russia’s trade credit and imports, coupled with self-sanctioning by Western companies that no longer want to do business with or in Russia.
What are the implications?
First, Western sanctions are working. They are working either directly (by cutting Russia’s imports) or indirectly (by causing capital flight). By the measure of real resources, Russia’s economy is suffering arterial blood loss at an increasing rate.
Second, Russia’s most likely retaliation will indeed be to reduce exports by cutting off energy supplies to the West. The rationale for this will be not only to damage Western economies but also to redirect capital and labour from the energy sector to Russia’s war sector.
It is sensible for Western countries to prepare for this. An efficient way to do so is to impose a tax on purchases of Russian energy, reflecting the risk attached to continued reliance (Sturm 2022). But it is also wise to ensure that, when the pinch comes, the blame for disruption is seen to lie where it belongs – with Russia.
Fourth, by pressing the unwilling – not only in Hungary but potentially in all Western countries – to do without Russian energy before the need arises, we are pointlessly spending NATO’s political capital (and sympathy for Ukraine) while exacerbating the national and social divisions on which Putin relies to make progress.
Finally, are there risks in allowing Russia to continue to accumulate financial claims on Western economies accruing from energy sales? Yes, but as long as sanctions on Russia’s imports and financial institutions remain in place these risks are long term. The shape of the long term will be decided by the outcome of Putin’s war, which is being decided now.
Shifting the focus from Russia’s energy exports is not an argument for doing nothing. Rather, it is an argument for preferring more effective instruments to less effective ones. It is far more important for everyone to do what it takes to help Ukraine win the war now, focusing first of all on Ukraine’s immediate military needs. We should not be distracted by worries about the distant financial implications of continuing to buy and pay for Russian energy for as long as we can – using cash that Russia cannot currently spend.
BBC News (2022), “Russia halts gas supplies to Finland”, 21 May.
European Parliament (2022), “MEPs demand full embargo on Russian imports of oil, coal, nuclear fuel and gas”, press release, 7 April.
Financial Times (2022), “EU leaders agree to ban majority of Russian oil imports”, 30 May.
Fortune (2022), “How Europe is trying to wean itself off its $1 billion a day Russia energy habit”, 9 March.
Klemann, H (2019), “Exploitation and destruction in Nazi-occupied Europe”, VoxEU.org, 11 September.
Shagina, M (2020), “Drifting East: Russia’s Import Substitution and Its Pivot to Asia”, Center for Eastern European Studies Working Paper No. 3.
Sturm, J (2022), “The simple economics of a tariff on Russian energy imports”, VoxEU.org, 13 April.
The Brussels Times (2022), “Russia demands gas payments in rubles: What does this mean?”, 2 April.
The Economist (2022), “Russia is on track for a record trade surplus”, 13 May.
The Guardian (2022), “Buying Russian gas and oil has funded Putin’s war, says top EU official”, 9 March.