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How Europe Can Sustain Russia Sanctions

Russia's war in Ukraine has underscored the need for Europe finally to invest more in its own defense and security. Such an outrageous act of aggression calls for harsh sanctions, which will require new policy mechanisms to help EU member states maintain solidarity.

MADRID – Russian President Vladimir Putin’s decision to invade Ukraine is a dramatic wake-up call for Europe. The European Union can no longer be a passive player in global affairs. It must reinforce its own security structure within the broader context of NATO.

The COVID-19 crisis offers important lessons in this regard. The intuition behind Europe’s response to the pandemic was that a common, symmetric, external shock to economic policymaking called for common, internally coherent, and consensual solutions. This translated into a political agreement to create a centralized spending initiative financed with funds raised by the European Commission. The new Recovery and Resilience Facility provided EU member states with the means – including through fiscal transfers – to respond to the health crisis and its economic consequences.

In the face of Putin’s blitz, Europe urgently needs a similar mechanism to finance investment in its long-term safety, and to help member states bear the economic cost of enacting meaningful sanctions against Russia. The steps needed to secure Europe geopolitically will be costly, and they will go beyond simply supporting our aging military forces.

Part of the cost will stem from the effects of sanctions, and part from the need to adapt to the new geopolitical environment. Not all EU members have enough fiscal capacity to absorb these costs. Some (such as Italy) have much higher levels of public debt, and others (such as Germany) are more exposed to the rebound effects of sanctions.

Moreover, no EU member can feasibly pursue rapid and full diversification away from Russian gas. As former Russian President Dmitri Medvedev has threatened, Europeans face the prospect of skyrocketing gas prices. And with Ukraine and Russia together accounting for almost 30% of global wheat exports, food also will be affected worldwide – a problem compounded by an increase in the price of fertilizers, of which Russia is a major producer.

The downside risks to the economy will therefore include new inflationary pressures on top of those associated with the post-pandemic reopening. Facing the specter of stagflation, the European Central Bank may feel more pressure to tighten monetary policy. If so, the expectation of rate increases might in turn force some countries into fiscal tightening, which would render meaningful additional security spending all but impossible.

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Nonetheless, a united Europe is needed now more than ever to maintain sufficiently severe sanctions against Russia, and to mitigate the short-term pain from Russian counter-sanctions. With European gas storage facilities still 30% full, and with the possibility of receiving additional liquefied natural gas (LNG), Europe can survive the winter even with an interruption of all Russian gas flows. But to manage this worst-case scenario, European countries will need to show solidarity by sharing scarce resources with those most in need, and by extending EU financial support to the most-affected countries.

After that, two more measures will be needed to ensure longer-term solidarity on energy issues. First, EU countries must (finally) build the gas interconnections that are needed to make the EU energy market more flexible and resilient to shocks. For example, pipelines connecting Spain and France would enable the rest of Europe to tap into Iberia’s large LNG infrastructure.

Second, EU countries must turn gas storage into a strategic asset. The companies that own storage sites should be required to fill them up ahead of winter, and EU member states should consider developing a regional strategic gas storage system like the US Strategic Petroleum Reserve.

Europe also needs to prepare itself to welcome war refugees. A mechanism will be needed for distributing potentially millions of refugees within the Union, and for supporting host countries financially. One possible blueprint is the EU’s Support to mitigate Unemployment Risks in an Emergency (SURE) initiative, which was rolled out during the pandemic to reinforce national social-security systems.

Moreover, Western companies and financial institutions hit hard by the effects of the war and new sanctions must not suffer liquidity crises. The Russian economy is likely to be abruptly disconnected from Western markets, and the Ukrainian economy will deteriorate fast. Many Western companies will be exposed to these developments and will need time and support to refocus their assets and business plans.

Europe’s response here should include activating new state aid exceptions under articles 107(3) and 109 of the Treaty on the Functioning of the European Union. But it must not stop there. As in the COVID-19 crisis, a straightforward suspension of the state-aid framework could produce a scenario in which rich countries are able to shield their markets much more than poorer countries can, undermining competition in the internal market. Europe therefore needs a facility to provide equal backing to all affected companies and financial institutions.

Finally, we cannot shy away from updating the aging European military infrastructure. In the past, EU countries have benefited from joint military procurement on specific projects through the European Defence Agency. This approach now needs to be scaled up substantially and backed by common resources, with guidelines that all assets purchased be used to reform and modernize the national units participating in EU-level defense through EU Battlegroup or NATO assignments.

The COVID-19 Recovery and Resilience Facility was successful because it accounted for different interests in the name of fighting a common problem. It should now be augmented with a security facility to provide financial support for the difficult measures that will be needed to sustain a united front vis-à-vis Russia. In addition to loans to deal with short-term issues such as illiquidity, there should be common spending to finance structural adaptation over the medium term, especially to support defense spending, refugee resettlement, and the energy transition.

Accordingly, the facility should be financed with EU bonds, which should be eligible for purchase by the ECB – thus also serving as a much-needed EU safe asset.

The Russia-Ukraine crisis will require rethinking how European countries allocate their budgets and govern key sectors, some of which are only loosely connected with defense and security. This transition is not a choice, but rather a necessary response to dark times.

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