Russia’s invasion of Ukraine is an unquantifiable but probably small blow to the UK economy.
Our direct economic ties with Russia are, in fact, small. Total goods exports last year were less than £3bn, just over 0.1 per cent of GDP and only slightly more than those to Denmark. Declines in these will be insignificant in macroeconomic terms even if they are only partly offset by increased exports of 'lethal aid' to Ukraine.
More important is the fact that Russia’s invasion of Ukraine is pushing up commodity prices. The UK consumes just under 1.6m barrels of oil a day. That means that each $10 per barrel rise in the oil price costs us just over 0.2 per cent of GDP. But oil isn’t the only price that’s rising because of Russia’s invasion of Ukraine. The price of natural gas has surged – albeit still below December’s spike – which threatens yet more price rises when the energy cap is reviewed later in the year. And non-energy commodity prices have also risen – by more than 20 per cent so far this year. With these accounting for 0.6 per cent of UK GDP (not much, because that’s one benefit of a deindustrialised economy) such rises cut real GDP even further.
On top of this, the 'London laundromat' – those bankers, estate agents and lawyers who benefit from Russian oligarchs’ wealth – is at risk. Granted, so far sanctions against the oligarchs have been small. But they could increase, as could the political backlash against London’s acceptance of Russian money.
Altogether, these effects add up to a small but noticeable blow to the UK economy. But there are other impacts.
One is that the world has become poorer simply because share prices have fallen. Granted, the war’s impact on share prices outside Russia has been small. But it has exacerbated a decline that was under way before. MSCI’s world index has fallen almost 10 per cent so far this year. We cannot quantify exactly how this will cut consumer and capital spending, because so much depends upon how investors interpret the fall: do they think 'I’m 13 per cent worse off than in December' or 'I’m still better off than a year ago'? The lesson of the 1987 crash and of the 2000-02 tech crash is that it’s easy to over-estimate stock market wealth effects. But that doesn’t mean they don’t exist.
On top of all this, uncertainty itself is bad for the economy because, as Stanford University’s Nick Bloom has shown, it encourages companies to delay investments. There are several aspects of such uncertainty. There’s uncertainty about commodity prices: how far will costs of production rise and for how long? There’s also uncertainty about demand: will lower share prices cut capital and consumer spending around the world and, if so, by how much? And will those economies with bigger ties to Russia (Germany exports six times as much to it as the UK does) suffer a bigger hit?
Another form of uncertainty is the impact upon interest rates. The latest rise in oil prices means that the spike in CPI inflation will now be even greater than the Bank of England thought a few weeks ago – over 7 per cent. That could encourage it to press on with rate rises. But the very same rises in oil and commodity prices will squeeze real incomes – which would be exacerbated by higher rates. That’s a case for the Bank to hold off a rate rise.
And then there’s an impact on animal spirits. Investment decisions are not taken solely by a cool-headed assessment of future costs and revenues – and nor can they be because the future is unknowable. Instead, as Maynard Keynes said, they depend upon the state of confidence. And it is difficult to feel more confident about the world when one’s fellow Europeans are being blown up.
Net, Russia’s invasion of Ukraine is bad for the economy. Of course, we cannot say exactly how much – but then the very fact of the invasion tells us that the world is unpredictable. Which is why investors need resilient and diversified portfolios more than an unattainable degree of foresight.
