How the War Against Ukraine can Change the Global Economy

Five consequences for global economic relations

The attack by Putin and the Russian leadership on Ukraine represents a turning point for Europe and the entire world. It will also change the shape of the international division of labor and globalization. We expect five central consequences for global economic relations in the coming years.

#1 Economic dependencies are reduced

The current international division of labor is characterized by a striving for the greatest possible efficiency. Core elements are just-in-time production and global single sourcing. Just-in-time production involves working with the lowest possible storage costs. In the case of global single sourcing, the supplier of an input who demands the lowest price – taking into account transport costs – is selected worldwide.

Both measures mean a high level of dependence on the timely delivery of inputs and raw materials. We saw how serious the economic consequences can be if these supply chain relationships are disrupted after the outbreak of the Corona pandemic, but also when the Suez Canal was blocked by a container ship in March 2021 – and now, during the Ukraine war.

Given the numerous supply chain disruptions in the recent past, it is likely that many companies will change their supplier relationships. This includes a larger diversification of supplier companies, in some cases by resorting to suppliers closer to home.

In addition, many companies will seek to reduce costs of production of critical inputs by increasing their use of digital technologies, so that they can produce these inputs themselves if necessary.

#2 Geopolitical considerations increasingly shape foreign trade relations

It can be assumed that in the future, international trade relations will no longer be viewed solely in terms of economic advantage, but also in terms of geopolitical considerations. This means that, in shaping their foreign trade relations, more and more countries are also aiming to achieve their political goals.

For example, the trade disputes between the U.S. under Donald Trump and China were not just about the U.S. trade deficit, but much more about global technological leadership. The reason: technological superiority is the basis for economic strength, and economic strength is in turn the basis for political and military power.

In general, it can be assumed that many economies will increasingly use trade policy instruments in the future in order to achieve their political goals. Possible instruments for this are tariffs, non-tariff trade barriers, sanctions, export restrictions, export bans and many more.

Following a longer phase of dismantling international trade barriers, increasing trade-restrictive measures can therefore be expected in the near future. This would be a de-globalization which implies the partial sacrifice of the specialization gains resulting from the international division of labor.

#3 Threat of bifurcation of global economy

One conceivable Russian response to the extensive economic sanctions in response to Russia’s attack on Ukraine could be to sell to China the natural gas and other fossil fuels it can no longer sell in Europe and the U. S. Chinese energy needs are great, so there would be a corresponding demand. Both countries have also been pursuing a strategy of “de-dollarization” for several years. They are increasingly replacing the dollar with other currencies, above all the euro.

Finally, it would be possible for Russia to receive Chinese consumer and investment goods directly in return for its oil and natural gas. The values of the reciprocal deliveries would then be offset against each other, so that monetary payments would only have to be made for imbalances that arise.

Taking this line of thought further, a world trade order could develop that is divided into two, consisting of one bloc of democratic, market-economy countries (U.S., Europe, Japan, South Korea, Oceania, North and South America) and another bloc of autocratic states (China, Russia and their most important trading partners). However, due to its economic size, Russia would only be China’s junior partner in this. Similar to the Cold War, there could also be a third bloc of countries (e.g., India) that try to avoid a clear assignment and continue to maintain their economic relations in both spheres.

The result would be an additional de-globalization, with the loss of many economic advantages of the international division of labor. However, it is uncertain whether this division will actually occur. Because of their economic power, Europe and the U.S. are much more important to China than Russia as buyers of Chinese products. It is therefore questionable whether China will risk worsening its economic ties with the West in the short term.

#4 Digitalization shortens the global value chain

Digital transformation in Europe is being accelerated by the Ukraine war for at least two reasons:

1. Digital technologies optimize production and business processes, reducing material input. This means less demand for fossil fuels and other natural raw materials. As a result, Europe will become less dependent on corresponding imports from Russia.
2. Digital technology reduces costs of production and thus makes it possible – at least in some areas – to manufacture important individual parts locally. That makes it easier for European companies to dispense with low-cost inputs from far-away countries. This reduces the economic disadvantages that arise in the event of a supply chain disruption.

The consequence of advancing digitization in Europe is that relocating individual production steps back to Europe from far-flung low-wage countries is becoming more profitable from a business perspective. Global value chains are being shortened as a result.

Unlike a reduction in the international division of labor as a result of protectionist measures, however, this is not an economic disadvantage because the existence of cheaper digital production technologies means that this form of division of labor is no longer worthwhile.

#5 Attractiveness of the ecological transformation is accelerated

The consequence of increasing supply chain disruptions in combination with increasing political trade restrictions and a disruption of trade relations with Russia are forcing the ecological transformation: The ecological transformation will reduce dependence on imports of fossil energy. The switch to emission-saving or emission-neutral production processes therefore makes sense not only for reasons of climate protection.

To achieve the goal of climate neutrality, the industrialized nations will increase their carbon prices and sooner or later also reduce subsidies for climate-damaging energy. In this way, they will increase the financial incentives for emission-saving technological progress. The desire for greater independence from imported fossil energies is additionally pushing these efforts.

Global demand for low-emission products will therefore increase. Green technologies and the products manufactured with them will therefore be a decisive international competitive advantage in the future. This secures jobs and income for people.

This also means that countries whose wealth is currently still based on the export of fossil energies (oil, natural gas, coal) will in the future experience considerable losses in their export earnings. The result will be job and income losses in these countries. The same applies to economies whose production plants stick to fossil energies – they will not be competitive in the long run.

Economic policy consequences for the EU

The EU has traditionally been an advocate of multilateralism and open markets. However, global developments over the past five years have shown that the resulting interdependencies, which are initially economically advantageous, can quickly become critical dependencies if they are exploited politically or at least make the EU vulnerable to blackmail. The dependence of individual member states such as Germany on Russian gas is a current and dramatic example of this.

The EU must adapt to this new reality, in which economics and politics can no longer be easily kept separate in the sense of “change through trade”. It has already begun to do so with the proclamation of a “geopolitical commission” and new instruments to defend its own sovereignty, such as the anti-coercion instrument.

In the future, the analysis and, if necessary, reduction of critical dependencies must play an even greater role for EU economic policy combined with a stronger focus on internal EU solutions. The global framework conditions will not change in the foreseeable future. The war in Ukraine makes this very clear.

In addition, the EU must focus on the technologies that are already needed today for the digital and ecological transformation or could even play a central role in this in the future. In this way, the EU may be able to limit critical dependencies in advance or even prevent them from arising in the first place.

About the authors

Cora is a senior expert in the Europe’s Future Program at the Bertelsmann Stiftung. Her research focus is foreign direct investment and international trade (especially the role of emerging economies). 

Thieß Petersen is Senior Advisor at the Bertelsmann Stiftung, specializing in macro-economic studies and economics. His focus lies on the causes and effects of financial and economic crises as well as the chances and risks of globalization. Most recently, he worked on the effects of carbon pricing and the benefits of a potential global climate club.

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Read more about the geopolitical and economic impact of Russia’s invasion of Ukraine:

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The Impact of the War Against Ukraine on the European Fiscal Reform Debate

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