‘Impose sanctions, if you must; but target the right people’ | Clint Flores

Economist CLINT FLORES argues that unless Europe also addresses the supply-chain problems caused by the war in Ukraine, its economic sanctions may end up hurting Europe’s economy more than Russia’s

Clint Flores
Clint Flores

Recently, you sounded a stark warning about the EU’s sanctions against Russia: “Don’t destroy the European economy, simply because you [the European Commission] made a miscalculation on inflation.” This echoes misgivings expressed by Finance Minister Clyde Caruana: who argued that “the people in the countries imposing the sanctions are being affected more than those in the country on which they are imposed.” Is this how you interpret the current situation: that the EU is hurting itself more than Russia, by imposing sanctions?

Let’s start by breaking it down into different segments. First of all, it is important to clarify that the current economic problems we are dealing with, are caused by the supply side of the equation: not the demand side.

Today’s inflation, for instance, is not being caused by ‘excessive demand for goods and services’; but by a shortage of supply.

And the war in Ukraine is not the only reason for this. First, we had the COVID-19 pandemic, which created shortages in the supply-chain. Then, those shortages were further exacerbated by problems in the shipping sector – with major international ports (including Shanghai) having to close during the pandemic – and on top of that, just as we were coming out of that crisis… we had the invasion of Ukraine.

What we are looking at, then, is a shortage of supply; which in turn will have an inflationary effect on prices: regardless of any sanctions. So unless we are going to take any measures to somehow ‘unlock’, or increase, that supply… the current inflation is only going to persist.

But what can realistically be done, to ‘increase the supply’ of a commodity such as Ukrainian wheat, for instance? (Short of ‘ending the war’, of course… which is, after all, what the EU sanctions are intended to do?)

There are ways in which some of the foodstuffs that are currently held up in depots in Ukraine – because it’s not just wheat, by the way; Europe depends on Ukraine for a lot of other food exports – could be released. The European Union is already establishing ‘solidarity lanes’, to create alternative routes for Ukrainian agricultural to be exported, for instance. 

If we take a longer-term view of the issue, however: we should also be exploring ways to increase the availability of agricultural land, in the rest of Europe: partly as a means of addressing the immediate shortages – though it would take a lot of time – but partly also to decrease our dependency on only a handful of countries (including Ukraine), for our most basic commodities.

Instead, however, the European Central Bank has chosen to increase interest rates – following in the footsteps of the USA’s Federal Reserve – but while that may be a means of curbing inflation, through monetary policy… I myself can’t see why they would raise interest rates now: when the real problem relates to the supply of commodities.

So unless we are going to increase the supply of wheat, foodstuffs, fertiliser - which is especially important, in view of the need to ‘speed up’, as it were, agricultural production – and other commodities, that are not being imported because of the complexities of sanctions… the problem of inflation will stay with us, at least for the short-to-medium term…

‘Because of the complexities of sanctions’: I take that to mean that the sanctions themselves have already contributed to the problem, somehow.  Can you expand on that?

This is the second problem I was coming to. One of the issues with sanctions – any sanctions – is that they always take time, to be implemented on the ground.

If you look at it from the perspective of the economic operators who will have to abide by them, for example: first, they have to actually understand the sanctions themselves – what it being sanctioned; who they can or cannot do business with, etc. Then, they have to adapt their business models, to fit the new regulations.

And this takes time. To give you an example from the United States: when sanctions were introduced [e.g., against Iran], economic operators were constantly asking the Office of Foreign And Asset Control (the agency that monitors and enforces US sanctions): ‘Listen, can we do this? Can we trade with this, or that company…?”

And the situation was so fluid, that they had no time to digest it all; to understand the consequences, if they did not abide by the sanctions. The bottom line is that it took those economic operators a while to adjust to the new reality; and this stifled their ability to do business, in the meantime.

This is true also of the EU’s sanctions on Russia: especially in view of how they were imposed… that is to say, both cumulatively, and consecutively. From the EU’s side, there were six separate packages of sanctions, all announced at regular intervals – on a weekly, then monthly basis.

Now: when imposing sanctions on any commodity, there will inevitably be a delay, as all the economic operators adjust to the new reality. And this is stifling imports from Russia, as well as – obviously – exports to Russia…

But surely, that was the whole point of imposing sanctions on the first place? To place economic pressure on Russia, by limiting its ability to import/export commodities…?

Yes, but we also have to ask ourselves who will ultimately be hurt more: the Russian economy, or the countries abiding by those sanctions?

When I was a student in Brussels, for instance, we had sessions with the International Red Cross. Its president, Peter Maurer, used to tell us: ‘OK, if you’re going to impose sanctions… impose them. But then, make sure you’re targeting the right people. Because ultimately, it will be the ordinary citizens who end up suffering’.

This is, in fact, what happened in the case of Iran. After the imposition of US sanctions, not even the most basic humanitarian and medical equipment was arriving in that country: not necessarily because they were on the sanctions-list; but because the economic operators involved, were under pressure to abide by those sanctions… so whenever they saw the name ‘Iran’, they felt they had to be extra-cautious, to ensure that they were doing business with legitimate companies.

Are you suggesting, then, that the sanctions on Russia are targeting the ‘wrong’ people?

Let me put it this way: [former Russian Opposition leader] Navalny gave them [the European Commission] a complete list of whom they should be targeting. The problem, however, is that they seem to have miscalculated the effects of the sanctions. I’ve already mentioned one of these effects: the delay caused by the implementation of those sanctions, as economic operators struggle to adapt to them.

Another problem, however, is that the sanctions themselves are limited only to commodities that Europe isn’t totally dependent upon. The most obvious example is that… the EU is still importing gas from Russia: for the simple reason that many European countries are still dependent on Russian gas.

Meanwhile, they imposed sanctions on oil – even on the sea-borne transportation of oil: which was aimed at halting exports to third countries, such as India and China. But it seems that India and China had both stockpiled oil, well in advance of the sanctions; and in any case, Russia is still exporting oil to India and China, regardless.

Clearly, then, the sanctions did not deter either the Russian invasion in the first place; nor did they stop Vladimir Putin from continuing to advance, even into the eastern part of Ukraine…

Apart from the efficacy of sanctions, however, you also seem to be suggesting that they may have a political impact on Europe. Pointing towards French President Macron’s recent woes, for instance, you argued that: “I hope populism doesn’t rise in Europe as a result of people not having enough food to eat.” How realistic is that prediction, based on current indicators?

If you look at history, and see what happened in the 1930s: the problem was that people were increasingly finding it difficult to ‘put food on the table’. And that, ultimately, is what fuelled the populism that led to the rise of a tyrant in Europe.

The rise of Hitler was not – as famously suggested by Austrian economist F.W Hayek – because the German government ‘grew too big’, and became too ‘interventionist’ in its approach, that it evolved into a dictatorship on its own; on the contrary, it was mostly down to the effects of the Great Depression: poverty, and the inability to feed one’s own family.

Now: what we are seeing today is a similar rise in the same populist narrative, also as a result of the same economic pressures. We see it in Italy, with Matteo Salvini; we’re seeing it France, with the renewed popularity of Marine Le Pen; and we see it every time there is a financial crisis, too: such as in 2008, for instance.

This, incidentally, is why it is also in Vladimir Putin’s interest to have a protracted war in Ukraine. It would continue to divide Europe, politically: and that will create further tension, on the ground… on top of the existing economic pressures to keep up with inflation.

So if the European people are going to end up with not enough money, to maintain a decent standard of living – and let’s face it: there are European countries where people are already resorting to food-banks, today – then, yes: what happened in the 1930s, could happen again.

Earlier you mentioned the possible impact, ‘especially on lower-income brackets’. Can you be more specific? What sort of economic impact are you expecting here in Malta, for instance? 

To be honest. I don’t see the problem being directly related to Malta, myself: partly because – unlike other European countries - Malta is not dependent on Russian gas; and partly because the government is actually stepping in, to subsidise most of the affected commodities: including fuel, wheat, and so on. So the problem, as I see it, concerns Europe, and the rest of the world… 

We are, however, dependent on imports for pretty much everything else; and if inflation affects all countries – not just Russia – the cost of imported goods (including all foodstuffs, etc.) will surely be expected to rise here as well…

But that’s what I meant. Inflation-wise, Malta has not, so far, been as badly hit as elsewhere: but only because, when it comes to wheat, fuels and other commodities… the prices spiked to a point, where government had to intervene, and subsidise the inflation. And obviously, that comes at a gargantuan cost to the public coffers.

So to come back to your question of how Malta will be affected: in the short-term, the problem is being addressed – at enormous cost – by government intervention, to cushion prices. In the long-term, however, the bigger concern is ‘imported inflation’: because there is no way to control the cost of importing goods and services from abroad.  

You’re saying it yourself, though: the only reason inflation hasn’t been higher, is because it is subsidised by government. Surely, however, there is a limit to how long the Maltese government can afford to absorb those price-hikes itself…

Not really, no.  As long as the economy keeps growing, it shouldn’t be problem. Because when you take the debt/deficit-to-GDP ratio… it’s just a ratio, at the end of the day. So if the economy keeps growing, and you maintain a constant debt, or deficit, relative to that economic growth: you can carry on indefinitely…

Indefinitely, perhaps. But sustainably?

It is sustainable. If your rate of economic growth remains higher than the rate at which your debt is growing: you can keep that ratio on a constant downward path…

OK: but all that means in practice, is that we would be satisfying the criteria of the EU’s ‘Growth and Stability Pact’. We would still have to depend on ‘indefinite economic growth’ in future, though. How sustainable is that?

The problem, as I see it – especially with the way some economists reason – is that they want to balance the books, ‘by the end of the year’. I see it differently, myself. You can also ‘balance the books’ over a cycle: of five years, or seven years, for example. You can have a short-, medium-, or long-term plan. In the EU, for instance, we have the ‘Multiannual Financial Framework’: a seven-year plan, which sets ceilings for how much governments can spend…

So if the government has a plan, which involves increasing public debt, yes; but also sustainably growing the economy, by providing the price-stability that gives peace of mind to future investors… I see no problem with it, myself. Because let’s face it: if we kill the future sentiment… we would be killing the investment of today. And obviously, if you kill future investment; you will also be lowering your economic growth.

So basically, I don’t see it as a question of sustainability… provided, of course, that the subsidies are targeting the right people.

Who would those right people be?

Personally, I believe that the upper-to-lower middle class shouldn’t be left out of the equation: because it would take longer for them to recover. I think that – after the lower-income brackets, of course:  government first has to think of pensioners; students; minimum-wage earners, and so on – that is where the funds should be channelled… because normally, the upper-middle income bracket tends to get hit hard, as well.

Higher-income earners, on the other hand, are better-positioned to withstand the effects of inflation. When you compare the actual effects of an 8% inflation – bearing in mind that is regressive inflation: which has the ‘double-whammy’ effect of both higher prices, and lower income – proportionally, it impacts the middle-income bracket far worse.

And besides: they are, after all, the people who support the economy the most, by paying taxes (often, at 35%)… whilst arguably, getting the least in return…