Monday, 3 March 2014

Six consequences of the Ukraine crisis for British government - Prof Perri 6, Chair in Public Management, Queen Mary

Image: Independence Square, Kiev, Ukraine - Credit: Sasha Maksymenko License: CC BY 2.0

Russia’s military intervention in the Crimea and perhaps more widely in the Ukraine will have longstanding consequences for government in Britain, and the impacts will be felt far beyond the Foreign Office and the diplomatic service. Six implications for British government are immediately obvious. In order from the shortest to the longest terms, six implications of the Russian occupation of the Crimea can immediately be identified for British government having to do loans, distractions, gilts, gas, missiles and boots and finally containers and pipes.

At the very beginning of March 2014, Mr Hague, Britain’s Foreign Secretary flew to Kiev, the capital of Ukraine, very quickly after the Russian military operations began in the Crimea. The full agenda of his talks with the government in Kiev are not known, although clearly he pressed the new government to stop provoking Russia with discriminatory laws on the Russian language.
      But it seems reasonable to wonder whether one item that the new and desperate government in Kiev might have wanted to raise with Mr Hague will have been money. And that means money right now. Bluntly, the Ukraine is all but bankrupt, and those words “all but” could well have to be deleted in two or three weeks. Once the country ceases to be able to pay civil servants, police officers, soldiers and others who provide vital services, the country could collapse very quickly and then almost certainly Russia would move in to fill the vacuum. So the Ukraine needs loans urgently. But from whom? Now that it appears to be sliding toward conflict, it is therefore sliding out of the condition in which it would be appropriate for the International Monetary Fund to lead the assistance. For the IMF’s job is to help reconstruction in peacetime. The European Union would like to help. But it cannot move quickly. Someone else needs to step in immediately to tide Ukraine over until the EU can agree a package of support. In principle, when there is unity in Washington, the US can move quickly. But unity in a scarcer commodity in Washington now than money is. And anyway US lending might be seen in Moscow as provocative, even as an escalation. Britain is hardly wealthy at the moment, and its own debt-to-GDP ratio is hardly the most impressive in the G7. Even if such an idea would survive the morning editorial meeting at the “Daily Mail”, the British government is in no position to make loans large enough to sustain the Ukrainian state for more than a few days and even then on an emergency basis. But in these desperate circumstances, to try to prevent a situation in which Russia would be able to justify taking over all of Ukraine, bringing its troops as far west as the Romanian, Hungarian, Slovak and Polish borders and bringing refugees pouring into those countries, some very, very short term British assistance might be worth considering, as a stop gap until the EU can put loans on to a more sustainable basis.

Mr Hague’s attention is understandably likely to be given over almost entirely to the Ukraine for the next few weeks. More generally, the time available for foreign affairs in Number 10, in the Treasury, across the Foreign and Commonwealth Office, the Department for Business, Innovation and Skills and the Department for International Development will be distracted from other countries about which Britain cares.
      One country that could find itself in a worse position as a result of Britain’s distraction is Bosnia-Herzegovina. In February, while twenty public leaders from Bosnia-Herzegovina were taking a month-long course that I designed for them with us at Queen Mary in London, a series of violent protests broke out in cities and towns across the Federation of Bosnia-Herzegovina. The expression of popular dissatisfaction with the condition of the economy, with high unemployment especially among young people, corruption and insufficiently accountable party political elites was beginning to galvanise opinion in the chancelleries of Europe. Britain has been playing a constructive role in calling for a new EU initiative toward Bosnia, and Mr Hague is one of the few foreign ministers in the EU who has recently shown much interest in the country. If even he now has little time to devote to the country, then it will lose one of the few voices in the Council of Ministers in the EU who remains willing to work toward some fresh engagement with Bosnia’s imbrangled problems. Because Bosnia’s position is pivotal for the whole of the western Balkans, inattention to its difficulties runs risks for the whole continent.

When armies move, markets panic, risk premiums rise or even soar, oil prices rise, stock markets plunge, money flees from risky assets toward gold and oil and toward the bonds of those countries which are regarded as safe havens. In the Treasury and especially in the UK Debt Management Office, no doubt modellers are slaving hard into the small hours over spreadsheets to calculate scenarios for the effect on the costs of servicing British government debt. Will British gilts be one of the assets regarded as safe enough to attract hot money? Or will the possibility of a stand-off between Russia and western countries lead investors to worry about Britain? After all, Britain is already heavily indebted; it will incur additional cash costs as a result of this crisis (see below); the Scottish referendum is beginning to cause jitters in the markets. It is too soon to tell which is more likely: the first days of trading after the Russian army moved into the Crimea appear encouraging, but this small movement of money into sterling assets including gilts may not last. As the implications of the crisis for global demand and for the British tax base become clearer, some volatile swings in British bond yields are quite likely, and the Treasury and the Debt Management Office will be thinking hard about whether or not to rush forward or postpone the rolling over of expired gilts.
      Just before the Ukrainian crisis, the Bank of England had allowed one of its monetary policy chiefs to talk in public of interest hikes beginning in the spring of 2015. Russian armoured personnel carriers may well have brought that date forward by some months. And an increase in bank rate will have implications within a few weeks for the yields on Treasury gilts which the taxpayers must pay to attract investors to induce them take the government’s debt.

For all the wild talk in some quarters, Europe is in no position to impose economic sanctions on Russia even if it wanted to. Germany and Poland need Russian gas, especially now that Mrs Merkel has announced that Germany will withdraw from dependence on nuclear energy following the Fukushima disaster. Much of that gas travels on pipes running through the Ukraine and civil servants in every energy ministry across Europe are rapidly having to become experts in the measurement of pressure in those pipes as they snake from the Russian gas fields toward European factories and homes.
      In the medium term, though, the Ukraine crisis will surely cause Europe generally and Britain in particular to put renewed effort – and, yes, that inevitably means more taxpayers’ money, either directly or in the form of guarantees – in pursuit of reduced dependence on Russia in gas and, to a lesser extent, oil. Even before the Russian army began to deploy in the Crimea, Britain was in urgent need of investment in new electricity generation plants, if we are to avoid rolling blackouts in a few years. Before March 2014, the policy priority was to find a technology that was not in decline (unlike North Sea oil and gas), affordable (as nuclear energy rarely is and wave energy still is not) efficient and scaleable (as onshore wind and biomass are not), capable of being introduced quickly (as nuclear energy is not) and capable of securing public acceptance (as hydraulic fracturing of shale gas may not be). Now that greater independence matters much, much more, the imperative has changed. Now Britain needs to choose just which mix of expensive, inefficient, slow-to-arrive, deeply unpopular, and environmentally risky or dirty options it will invest in, and must accept that, in various different ways, the taxpayer will have to stand behind much more of the private sector investment if it is to get done at all. The day to day fiscal consequences will not be large immediately, but the measure on the government balance sheet of what accountants call “contingent liabilities” – that is, money that might have to pay out if things go wrong for the energy generation companies – will quickly start to look ugly.

Missiles and boots
Since the fall of the Soviet Union in 1991, British defence reviews have consoled the politicians and the taxpayers that the “new world” after the end of the cold war would be one in which money would be better spent on boots and small arms for special forces and divisions of flexible marines, on cyberwar defence, on counter-insurgency, on humanitarian interventions, than on big missile and anti-missile shield programmes, nuclear warheads, submarines, massed tanks and on Arctic and satellite early warning stations. Small rogue states and global terrorist movements were supposed to be the main enemies. After the Ukraine crisis, this will look dangerously complacent. Whenever or however Mr Putin eventually hands over to a successor, Britain’s defence planners must now prepare for another generation or perhaps two in which Russia will represent as big a strategic threat to western Europe’s security as she did in eighteenth and nineteenth centuries, when, as now, Russian nationalism rather than communism inspired her leaders’ policies. In those centuries, unlike the period from 1945 until at least Stalin’s death in 1953, western Europe was rarely at risk of invasion and enduring occupation by Russian troops. But Russia can and presumably will again be a strategic threat in many other ways.
      Preparing for this will be more expensive for the British taxpayer than the defence spending forecasts prepared before the Ukraine crisis would suggest. There are no cheap ways of playing a full part in NATO which must deal with Russia again in its present mood.

Containers and pipes
It has become a cliché to note that one period of globalisation in trade and finance ended in 1914 and that another could end in 2014. Of course, the Ukraine crisis alone will not bring about a reversal as large as that of the Great War. Today, China’s importance to the world economy is sufficient alone to sustain high levels of world trade and financial integration, quite apart from the contributions of the US, Japan, India and others. But it will surely push European countries toward import substitution in gas and to a lesser extent oil. If the crisis is not resolved quickly, it could affect many emerging markets which are already struggling as they fear the consequences of the expected “tapering” by the US Federal Reserve for their currencies. More generally, this crisis could choke off recovery across the Atlantic countries and could herald reduced volumes of trade moving on the great container ships and along the pipes of global commerce for some years.
      For Britain, which is already finding that its consumer-led recovery is sucking in imports much faster than its firms can improve their fragile export performance and which is therefore seeing its balance of trade deficit actually worsen as GDP begins to grow again, the dampening effect on its economy and therefore on the government’s tax base a new gathering stand-off between Russia and the west could be quite serious. This is only blade in the pair of scissors threatening investment and trade, from a British perspective. Combined with the prospect of a referendum in 2017 on continued EU membership, should the Conservatives win the 2015 general election, the aftermath of the Ukraine crisis could cut significantly into British capabilities achieving the target, shared by all three major parties, for economic and therefore fiscal stabilisation by 2020.

British government after the Ukraine crisis

Just as was the case in 1973-4 when the Yom Kippur war broke out leading to a standoff between the US and USSR and when oil prices were forced up by OPEC, no doubt there will already a “MISC” cabinet committee meeting in Whitehall to think about the wider implications for Britain of the Ukraine crisis. Surely, each of the departments whose problems are discussed here will be sending their ministers. We have to hope that the quality of British government strategic response in 2014 is better coordinated, better briefed, and that ministers are more capable of long term thought than was the case in late 1973 and early 1974. Unfortunately, the present coalition government has only a little over a year to run before the general election, tensions between the two governing parties are growing and relations between ministers and top civil servants have been fractious and mistrustful in recent months. If anything can concentrate minds in Whitehall, these six implications certainly should.

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