Conflict has a vastly different impact on different economies based on how insulated it may be (either voluntarily or through sanctions) from the US-led Western financial system and the measures it may take, if any, to adjust to the economic fallout of the conflict.
Two ongoing conflicts – Russia versus Ukraine (began in February 2022) and Israel against Hamas/He zbollah/Houthis/Iran (7 October 2023) – present a significant contrast. Israel’s exposure to Western economies in general and the US in particular is pervasive. Israel received: (i) cumulative foreign assistance of 310 billion dollars in total (non-inflation adjusted) as per the US Council on Foreign Relations website, with 80 billion dollars in economic and 230 billion dollars in military assistance. Post 7 October 2023 the US spent 17.9 billion dollars that constitutes the highest military assistance to Israel by the US in any given year.
Annual grant aid is budgeted at 3.3 billion dollars under Foreign Military Financing with Egypt a distant second with 78 billion dollars economic and 90 billion-dollars military aid after it signed the 1979 US brokered peace treaty with Israel; (ii) at least 500 US companies are active in Israel including US venture capitalists while Israeli investment in the US was estimated at 41.6 billion dollars till 2021; European Union financial institutions provided 36.1 billion dollars in loans and underwritings and hold 26 billion dollars in shares and bonds in companies selling weapons to Israel. Since 2008 the Europeans have budgeted 75 million dollars to 84 Israeli entities on a total of 132 security projects (arms manufacturing); Germany is the largest exporter of arms to Israel, after the US, and increased exports tenfold to 354 million dollars post-7 October 2023; and (iii) free trade agreements with US (since 1985) that created more US jobs per export dollar relative to any other nation with an EU-Israel Association Agreement (2000) aimed at providing appropriate legal and institutional framework for political dialogue and economic cooperation. EU is Israel’s biggest trade partner, accounting for 28.8 percent of its trade (31.9 percent of imports from EU and 25.6 percent of its exports to EU) while EU trade with Israel represents a mere 0.8 percent of its total trade.
The obvious inference from such massive and sustained US engagement indicates unwavering support across the political divide that international affairs academics decode as the power of the Israel lobby – a power that so far remains unshaken within the US political sphere and is prevalent in the narrative of the two presidential candidates – Trump and Harris.
This support is in spite of the uploaded scenes of horrendous atrocities by the Israeli defence forces on social media that have generated protests in the US and Europe on a scale not seen during any of the previous conflicts. Recent surveys show that the majority of the under 40-year-olds in the West are no longer supportive of Israel.
Be that as it may, the prospect of a possible change in US policy towards Israel (and by extension by US European Nato allies) is very slim in the short to medium term (and perhaps not till there is a generational change in the US political landscape and administration).
There is, however, little doubt that Israel’s reputation has been severely marred post-7 October 2023 Hamas attacks – a factor that may have short to medium implications on some companies’ decisions to continue to invest in Israel. This, in turn, may have been a factor in Moody’s two notch downgrade – from A2 to Baa1 – credit rating is used by sovereign wealth funds and other investors to gauge the credit worthiness of a country’s borrowing costs.
The downgrade is therefore reflective of an assessment that Israel may not economically recover as quickly as it did after previous equally brutal conflicts in terms of loss of Palestinian and Lebanese life. The Israeli Accountant General however acknowledged that the war on several fronts would exact an economic price but said there was “no justification” for Moody’s downgrade.
Israeli Gross Domestic Product growth rate for 2023 was estimated at 2 percent, a 4.84 percent decline from the year before and on 15 October 2024 the Bank of Israel further lowered its growth estimate to 0.5 percent in 2024 – down from the earlier 1.5 percent; and warned that the interest rate may have to be raised to control the spike in inflation though it was kept constant in the sixth straight policy meeting.
Russia sanctioned by the US and its allies in February 2022 has not been rated since March 2022 – on 17 March 2022 Standard and Poor’s rated Russia at negative watch (from CC) and on 6 March 2022 Moody’s at negative (from Ca). Russia’s 300 billion dollars parked in the US and Europe were frozen in 2022 and the interest payable on this principal amount was recently used as collateral by the US and the Europeans to lend 20 and 35 billion dollars respectively to Ukraine as its war chest, which Putin has dismissed as theft.
In marked contrast to Israel, Russia’s growth rate for the current year is projected at 3.9 percent – up from the projected 2.8 percent by Finance Minister Siluanov in April this year.
For those who may consider this an overstatement by Russian authorities need reminding that analysts polled by Reuters projected Russia’s growth rate at 3.6 percent for the current year. The reason: large scale spending on arms manufacturing leading to a tight labour market and strong consumer demand, in spite of an interest rate of 18 percent.
The age-old guns versus butter argument that economic students grapple with in freshman year have assumed great relevance: the moral/ethical argument veers towards production of butter instead of guns though international power players have never abandoned production of guns even during times of relative global peace (mainly by exporting to troubled spots around the world) and simply enhance production to full capacity during times of conflict.
From an economic perspective this leads to one conclusion: whatever the nature of the output, butter or guns, a rise in output will generate employment opportunities. And as is the case in Russia today the wave of nationalism is providing support for the war (that is simply not being tempered by the Western narrative) especially as there areno food shortages or huge Russian fatalities.
The effectiveness of sanctions, increasingly referred to as dollar weaponisation, has been declining as their use has augmented.
The Biden-led US administration has been by far the most prolific sanctioning authority in US history with 15,373 active sanctions to date, while Switzerland is in second place at 5062 and the European Union at 4808. According to the Office of Foreign Asset Control (OFAC) after President Clinton each subsequent president raised sanctions; and though Biden has set up a new department tasked to evaluate the efficacy of sanctions, indicative of some concerns, yet so far the US policy of sanctions is not visibly abating and nor is the US allowing its European allies to take decisions independent of its own foreign policy paradigms – sanction Russia and continue to support Israel in spite of the rising Israeli atrocities.
The countries that curtailed fuel supplies from Russia as per US pressured import sanctions are projected to fare much worse than Russia: Germany projected a 0.2 percent growth in 2024 (downgraded to negative 0.2 percent), France 0.9 percent in 2024, Italy 1 percent and Hungary which did not slash its fuel imports from Russia 2.4 percent in 2024.
The ongoing Brazil, Russia, India, China and South Africa (BRICS) meeting (with membership expanded to include five more full member countries) held in Kazan last week focused on hastening the process of delinking global trade and money transfers from the Society for Worldwide Interbank Financial Telecommunication (SWIFT) system; however, this will be a slow process and as per J. P. Morgan’s recent study de-dollarisation is evident in foreign exchange reserves, where the dollar’s share has declined to a record low of 58 percent, but the renminbi’s global footprint is still very small – 2.3 percent of SWIFT versus the dollar’s share of 43 percent and Euros 32 percent.
The US regards sanctions as a legitimate foreign policy tool (the only tool between diplomacy and war as per Reinsch, a Commerce Ministry official) but the fallout of this tool has been to bring the sanctioned countries together - Russia, Iran and North Korea – both from a political and an economic perspective.
Chinese products recently slapped with crippling tariffs by the US and EU (accused of subsidising its exporters) while India’s refusal to stop Russian oil imports (unlike the subservient EU) has strengthened the BRICS members’ resolve to present an alternate to Western hegemony that is premised on an assumption that is increasingly no longer valid: that of a unipolar world.
To conclude, more empirical study is required to make an informed conclusion on the economic fallout of a guns versus butter paradigm as well as the efficacy of sanctions from a global economic and political perspective – necessary as the footprints of there no longer being only one global superpower are clearly visible.
Copyright Business Recorder, 2024