Fabrizio Bensch / Courtesy Reuters German Chancellor Angela Merkel arrives for a session of the lower house of parliament in Berlin, March 20, 2014.

Bad Company

Why the West Is Weak on Russia

Over the past few days, as Russia has proved unwilling to live up to the terms of the April 17 Geneva agreement on Ukraine, Western nations have ramped up their condemnation of the country. U.S. Secretary of State John Kerry accused Moscow of “distraction, deception, and destabilization” for backing ethnic Russian separatists in eastern Ukraine. Meanwhile, the G-7 (formerly the G-8, before Russia was ousted earlier this year) rebuked the country for taking “no concrete actions in support of the Geneva accord” and threatened to impose additional sanctions, which, according to British Foreign Secretary William Hague, would be “more far reaching” than any before.

In the event, those far-reaching sanctions fell short. To be sure, a few powerful and well-connected individuals have recently been added to the West’s economic blacklist, but there is little chance that this latest round will do much damage. The West has the weapons for meaningful financial warfare, so why is it being so shy about using them?

As has been widely reported, the Russian economy is in dire straits. In 2013, Russian GDP growth slowed for a fourth consecutive year to a mere 1.3 percent. Now, as capital flees the country -- in the first part of the year, withdrawals have been as high as $60 billion, equal to the total in 2013 -- the economy is likely flatlining. S&P has downgraded Russia’s sovereign foreign currency rating to just one notch above junk, Russia has cancelled government bond sales, its Central Bank has imposed two unexpected rate hikes to stabilize the ruble, and international banks are increasingly declining to provide loans to Russian state banks and businesses.

Nevertheless, Russian President Vladimir Putin remains defiant, with his public approval ratings still high and his unwillingness to talk down the actions of pro-Russians inside Ukraine steadfast. To change that, sanctions would have to impose a meaningful cost. The fact that the West hasn’t opted to exact a real price for Putin’s behavior reveals that, perhaps, interests other than containing Russia are guiding decision-makers.

EUROPE’S CATCH-22

European leaders, in particular, are in an unenviable position. Europe as a whole relies heavily on Russian energy exports. Italy and Germany source up to a third of their natural gas from Russia, and the Baltic States and Finland rely entirely on their neighbor. Optimists argue that in the long run the crisis in Ukraine could play to Europe’s benefit because it could trigger a long-overdue restructuring of EU energy markets away from dependence on Russia. Pessimists counter that Europe, ever slow to reform, will be impotent in the face of fear that the lights will go out on its citizens.

The energy challenge is not the only economic pressure on European leaders. The continent’s businesses have also invested heavily in relations with Russia over the past 20 years and are wary of losing those ties. The European Union is by far Moscow’s most important business partner. At approximately $373 billion, the EU accounted for over 40 percent of the international community’s trade with Russia in 2012. The United States, in contrast, contributed less than $27 billion to Russian trade. That is on par with the investments that Germany, a far smaller economy, has made on its own. According to the Committee on Eastern European Economic Relations, 300,000 jobs in Germany depend on trade with Russia, 6,200 German-owned companies are active in Russia, and those companies have $27 billion invested in Russia.

It is thus not surprising that, fearing their bottom lines, energy companies such as Germany’s BASF, Austria’s OMV, Italy’s ENI, and the UK’s BP (owner of a 20 percent stake in Russian energy giant Rosneft) are lobbying against sanctions. It is also understandable that a number of chief executives, including that of Siemens, have made visits to Putin in recent weeks -- and that Adidas, ThyssenKrupp, and Deutsche Post have all criticized EU policymakers for their approach to Moscow.  As some noted, it was likely that German Chancellor Angela Merkel shared these concerns with U.S. President Barack Obama when the two met last week.

European leaders have allowed themselves to become mired in a catch-22. They seek to force Putin to change course by threatening economic damage. But, fearing the economic blowback that sanctions may inflict on their own countries, they allow corporate self-interest to justify a weak and divided response.

And it isn’t even clear that these fears are well founded. As Bernhard Reutersberg observed when he was CEO of the German utility EON-Ruhrgas, the last time Russia exercised its revanchist impulse and invaded Georgia, Russia was still a reliable energy partner and the gas kept flowing to Europe. In fact, Russia even kept gas lines open during the Cold War. Alexander Medvedev, the deputy CEO of Gazprom, has echoed that sentiment. Gazprom and Russia’s other commodity suppliers need sales to raise foreign currency to service debts and investment. They won’t get that in Russia. More broadly, the Russian economy needs the supply of skills, technology, and imports that Europe can provide. The country’s reliance on the international financial system is existential.  In other words, although retaliation and some collateral damage is unavoidable, Russia’s economy could not afford the kind of response that some in Europe fear.

Meanwhile, in contrast to EU corporations’ lobbying against sanctions, Poland and the Baltic States have clamored for more. For them, Russia’s actions in Ukraine and the proximity of their capital cities to the Russian border are simply bigger issues than the potentially significant extent to which a real tightening of sanctions might affect their energy supplies and economic well-being.

Obama has rightly observed that some EU nations will need to make difficult choices on sanctions because of their vulnerability. Thus far, the EU’s bigger nations appear to be listening to the cautionary advice of their leading corporations, despite the urgings of their more vulnerable Eastern European partners.  The EU economy remains weak with few meaningful signs of improvement for individual income and growth. Thus, until no other options remain, it seems likely that European politicians will seek to protect their national industries while hoping that the threat of truly meaningful sanctions will negate the need for action. 

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