NewsEuropeThe war economy arrives in Europe

The war economy arrives in Europe

The West is not exactly at war with Russia. However, it’s not exactly at war either. Western weapons have helped Ukraine to slow down the Russian invasion and even fight back, while it is clear that economic sanctions have created serious problems for the invader’s industry.

Russia has retaliated with a de facto embargo on natural gas exports to Europe. The decision shows how Putin thinks the war is really going. The conflict will end up having enormous long-term costs: no one will ever see Russia as a reliable trading partner again. But Putin seems willing to shoulder those costs in an attempt to intimidate the West into reducing its support for Ukraine, which he would not do if he had confidence in the military situation. In any case, the embargo has added risk to the economic bet. Six months ago, there was a lot of talk about whether Europe could or should stop importing energy from Russia. Well, Russia has made that decision.

And Europe seems poised to respond by doing what democracies always do when faced with wartime inflation: tax windfall profits, control prices, and (probably) impose rationing.

Before going into it, let us point out that, at least for now, we are talking about a specifically European problem. Right now, the United States is on something of an inflation vacation, largely thanks to falling gasoline prices, but also a reflection of other factors, such as plummeting shipping costs. However, Europe has allowed itself to become hugely dependent on gas shipped from Russia.

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It is important to understand the nature of the problem posed by this interruption. Physical gas shortages, while real, shouldn’t be crippling: Europe currently has more gas in storage than normal, and between conservation measures and alternative energy sources, the continent should be able to get through the winter without freeze. The essential problem is rather financial, and ultimately social. European gas prices have soared and, as buyers turn to alternatives, prices for other energy sources, including nuclear, renewables and coal, are skyrocketing as well.

Europe is facing a huge energy deficit and rising prices provide an incentive for everyone to fill it. Consumers will have an incentive to lower thermostats, upgrade insulation and pull on a sweater, and producers to maximize production and increase capacity. Letting markets do their thing is effective policy.

It is also grossly unfair. Energy producers whose costs have not risen will reap huge profits, while many families and some businesses face financial ruin from skyrocketing energy bills. Lecturing losers about the importance of incentives for effectiveness is not going to appease them.

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There is also a macroeconomic risk. Europe still has powerful unions, and some of them will also be in a position to demand pay rises to offset rising costs of living. The result could be a wage-price spiral, and reversing it would be expensive.

So just letting energy prices go up is not really an option. And what if a single check was handed out to compensate families for rising energy costs? In theory it may seem like a good idea, as people would still have an incentive to limit energy consumption. But, in practice, different families, even if they have similar incomes, can have very different energy bills, and people who live in a poorly insulated house will not be able to solve the problem overnight.

It seems that Europe is about to do what democracies always do when faced with wartime inflation: try to protect citizens from large price increases, and also try to avoid extremely high profits at a time of suffering for the population.

On Wednesday, Ursula von der Leyen, president of the European Commission, made a statement on energy calling for “a mandatory target for reducing electricity use” (i.e. rationing), a “revenue cap” from cheap energy producers (ie price controls), and a “solidarity contribution” by fossil fuel producers (ie a tax on excessive profits). Von der Leyen is not head of government and has very little direct power. Still, the measures she has proposed surely give us a pretty good idea of ​​where Europe is headed.

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It will work? Of course, the details will be crucial. One hopeful sign is that it is clear that Europe is not going to do like Nixon and try to curb inflation with controls while stimulating the economy. Rather, these kinds of wartime controls will be applied at the same time that the European Central Bank sharply tightens monetary policy, with considerable risk of triggering a recession.

We are receiving a lesson on the march of economic policy realities. You can’t—indeed, you shouldn’t—always let markets run amok. It would be bad if the emergency controls that Europe seems about to impose were made permanent. But, at this time, protecting families and preserving a sense of fairness must take precedence over the efficiency of the market that the textbooks talk about.

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Source: EL PAIS


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