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War and the economy: the future of Europe

Digital format, 08/06/2022, Aspen European Dialogue

The current global macroeconomic picture is a difficult one to interpret due to the overlapping effects of the pandemic and the repercussions of the Russia-Ukraine war. Thus, structural uncertainty is joined by contingent factors, the most worrisome being the possibility of full-blown stagflation or, in any case, of inflationary pressure coupled with steadily declining growth.

A specific European approach to managing economic crises can be identified in all this; indeed, the Covid response has introduced a new instrument – the Next Generation EU – and the suspension of the Stability and Growth Pact. The resources now earmarked for Member Countries are not only meant to sustain growth but also to transform industry. The SURE mechanism is equally important, especially to the mobilization of private resources in the pursuit of common goals.

The Russia-Ukraine war has complicated things however, not only in the energy sector, introducing the need for industry to reorganize even more rapidly in order to manage the costs of sanctions and inflation more sustainably. The concept of sustainability has come to be understood in both environmental and geopolitical terms and, in the case of energy, most importantly as diversification of sources.

In any case, global governance is in need of revision, and Europe can contribute to that especially through the role the euro is capable of playing in a more developed financial market.

The internal repercussions of the sanctions against Russia are cause for concern. Indirect effects over the short run are accentuating the asymmetries of energy choices and therefore threatening Europeans’ unity of intent; over the medium term, they jeopardize the green transition and, finally, revive the threat of inflation.

From the standpoint of inflation, an additional difficulty lies in the fragmentation of national markets in some sectors, particularly regarding fiscal policies, which are reflected in differing market assessments of national debt sustainability. Governments are justifiably taking temporary measures to protect the lowest income brackets, yet over the medium term subsidies are a risky and insufficient solution. A longer-term solution lies in investments in innovation that were already planned before the war broke out.

Becoming equally essential is Europe’s greater capacity to activate a common security and defense policy; indeed, protecting its interests on global markets and along trade routes and technological production lines calls for a wider spectrum of instruments.

From the global projection standpoint, Italy and Germany share particular responsibility within the EU, owed both to the changing composition of their energy supplies as well as to the deep industrial policy changes each has made as major manufacturers – even before the Russian crisis. Given their economic importance, close coordination is decisive to the EU’s internal cohesion and, at the same time, to vital trans-Atlantic relations.

Some aspects of the current economic phase could suggest the image of a war economy, but overall the behavior of the markets and the policies thus far enacted by governments indicate a productive system under pressure and highly volatile, but not in all-out war mode.

Phenomena such as reshoring are already underway, but it is too soon to tell whether that corresponds to actual “de-globalization”. What is coming though is a different form of globalization, if for no other reason than that the last two decades were marked by some historic anomalies such as extremely low inflation, ample availability of investments and a desire to exploit the impetus of international trade to fuel growth – anomalies that are now running out of steam.

The structural problem is that reshoring, combined with the green transition and the scarcity of some resources, has a structurally inflationary effect beyond the contingent factors capable of affecting prices. In particular, incorporating the famous “carbon footprint” into consumer prices certainly has a certain inflationary thrust; an effect that was not only anticipated but also welcomed up until a short time ago. Today’s dilemma is how to handle the undesired and indirect consequences of this general trend without cutting into growth.