Russia, Ukraine and U.S. Economic Policy

"The current challenge for U.S. policymakers is to deploy the tactics of international isolation and economic pressure without sacrificing long-term business interests..."

Editor’s Note: The following is the fourth and final of a series of articles from the Center for the National Interest’s new report: Costs of a New Cold War: The U.S.-Russia Confrontation over Ukraine. You can read the full report here.  

Preface

The crisis in Ukraine pitting Russia against the West reveals competing narratives regarding precipitants of and reactions to the February ouster of Viktor Yanukovych and the troubling episodes that have since unfolded in Ukraine’s south and east. This paper will assess the economic context of U.S. decision-making in response to the crisis in Ukraine, examining what is at stake economically for both the United States and Russia, the policies pursued and their potential consequences, and options to consider going forward.

Introduction

For nearly a quarter-century since the breakup of the Soviet Union, the United States and Russia have struggled to adapt to changes to the international system brought about by the Soviet collapse, the end of bipolarity, and the departure from the ‘stability’ of the Cold War era. The Cold War may have been expensive and dangerous, but it was also at least somewhat predictable. Analysts and decision-makers grew comfortable operating within a governing framework of organizing principles built over decades.

The purpose and predictability of that framework were not replaced by a set of equally convenient parameters for U.S.-Russia engagement. The bilateral relationship ebbed and flowed through periods of ‘warmer’ ties, which were occasionally buttressed by shared interests, although they were frequently a function of leadership personalities and the relief felt by the absence of conflict. As Russia emerged from a decade of upheaval that was the 1990s, opportunities for more serious common pursuits between Moscow and Washington emerged, yet so too did divergent national interests that were not fully understood without the benefit of hindsight. Cooperative successes were achieved, yet competition and conflict also endured.

A decade ago, in June 2004, the Orange Revolution in Ukraine introduced a new variable into Russia’s relations with the West. The view of the world from Moscow changed suddenly and significantly, and subsequent discussion of a NATO Membership Action Plan for Ukraine ensured that this was not a fleeting concern in Moscow (and the August 2008 Russia-Georgia war confirmed for U.S. policymakers that we had indeed entered a new phase in the relationship). Through electoral gaming, exertion of economic influence, and leverage of energy supplies, Russia and the West competed in a sometimes subtle and lengthy tug-of-war over Ukraine, culminating in the bidding war between the EU and the Russia-led Customs Union (now the Eurasian Economic Union) last fall, which precipitated the crisis in Ukraine.

As pro-EU and anti-Yanukovych protests transformed Kyiv’s Independence Square into the Maidan movement in late 2013, few on either side could have envisioned where U.S.-Russian relations would be in mid-2014, in the midst of the worst crisis since the end of the Cold War, with Ukraine engulfed in a low-grade civil war.

Russia’s Economic Backdrop

Russia’s Ukraine strategy and the annexation of Crimea in particular have been a boon politically for President Putin at home, as his approval rating soared to 72% in March, 82% in April, and 83% in May. But this conflict comes at a time when Russia can least afford it economically. Russian economic performance has deteriorated since its recovery from the global recession, and the country’s economy has been sliding into a period of stagnation for more than a year now. Whereas Russian GDP grew 3.4% in 2012, growth declined to 1.3% in 2013. The projections for 2014 began at an optimistic 2.5%, but the consensus view has since been reduced by half—to approximately 1.1-1.3%, with the OECD’s revised projection on the low end, at 0.5%.

These estimates are not weighted for Ukraine-related risks and impact. Leaving aside the effects of investor behavior and punitive actions taken against Russia, the best-case scenario growth projection hovers around 1.3%. When potential fallout from Ukraine is factored in, this is commonly viewed as enough to tip Russia into recession, with expected performance dropping to -2%. The IMF already considers Russia to be in recession.

Bloomberg recently conducted a survey of 10 economists, who assessed the probability of a Russian recession occurring this year to be 33 percent. This same group of economists largely concurred that the consumption effect supporting Russia’s recent rebound has run its course, and that the primary driver of any near-term economic growth must be investment.

In the second quarter of 2014 (Q2), the Russian economy grew by .8% year-on-year (y-o-y) compared to Q1 2013, the slowest pace in five years since the recession, which followed .9% y-o-y growth in Q1 and a contraction of .5% from Q4 2013. Russian and international observers agree that declining investment is the culprit—Russia’s own Ministry of Economic Development reported that fixed capital investment declined 4.8% in April y-o-y.

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