Monday 28 February 2022

Russia will lose the war

 Russia is a small country. From an economic perspective, that is. The gross domestic product (GDP) of Russia is about the same size as the combined GDP of Belgium and the Netherlands. Even if you add those two countries together, you still have a small country. Russia's GDP represents barely 10% of the EU's GDP. Russia is an economic dwarf in Europe.

Can such a small country win an intense war against a country that is resisting tooth and nail and that will have to be occupied for a long time? My answer is no. Russia does not have the resources to do so.

To win such a war, Russia will have to drastically increase its military spending. Russia today spends about $62 billion (nearly 5% of its GDP) on the military. That's 8% of US military spending. Such a military budget will not be sufficient to continue waging an intense and protracted war. More military spending will have to be made. But military spending is economically wasted. The tanks and combat aircraft that must be produced to wage the war are investments that are economically useless. This contrasts with investments in machines (and other production factors) that make it possible to produce more in the future. Tanks and fighters will not allow one extra ruble of production in the future. They will, however, put further pressure on productive investment. The economically small country that Russia is today will therefore become even smaller in the future.

Instead of cutting back on productive investment, the Russian dictator could cut consumption in Russia to make way for more military spending. The fact that Russia has such a small GDP while the country has 146 million inhabitants (more than 5 times the population of Belgium plus the Netherlands) hides the fact that most Russians live in relative poverty. Putin will have to push them even further into poverty to realize his megalomaniac ambitions. It is doubtful whether this policy will strengthen his dictatorship.

There are other effects to be expected from a policy that pushes a country into a war economy. The incomes earned in the war industry will not be able to be spent on consumer goods because these are in short supply. As a result, inflation will rise sharply. The temptation will be great to introduce price controls. The result is known: rationing and scarcity. Paradoxically, this will fulfill Putin's ambition: a return to the Soviet Union with its long waiting lines in front of  the shops.

Russia is economically a small country; it is also an underdeveloped country. It has a production structure of a typical African country. The country mainly exports raw materials and energy (gas and crude oil). They make up 80% of Russian exports. Imports are concentrated in manufacturing products (machinery, transport equipment, electronics, chemicals, pharmaceuticals). Those products represent more than three quarters of total Russian imports.

The problem with such an underdeveloped country is that export earnings are subject to large fluctuations. Today, energy and commodity prices are very high. That has allowed Russia to pile up more than $600 billion in international reserves (dollars, euros, pounds, gold). It has also boosted the budgetary revenues of the Russian government. But those are temporary effects. They have created the illusion that Russia has the resources to wage a protracted war.

It is already clear that this is an illusion. About half of these international reserves are now being frozen by the punitive measures imposed by Western countries. This also makes clear how dependent an underdeveloped country is on the Western powers that control the international financial system. The vast stock of international reserves now available to Russia is not a source of power, but its Achilles heel.

Moreover, these high commodity prices are a temporary phenomenon. “What goes up must come down”. Gas prices, oil prices and commodity prices will fall again and will reduce the resources available to the Russian government today and make a protracted war impossible.

Russia may cut off deliveries of gas to Europe in response to Western sanctions. This would certainly be painful in the short run in those countries that foolishly have made themselves dependent on Russian gas. If Russia cuts its gas deliveries today this would, in the longer run, destroy one of the pillars of Russian foreign revenues as European countries would look for alternatives. It would reduce even further Russia's resources to wage war. 

Russia is economically a small and fragile country. It is of course a large and powerful country thanks to its nuclear arsenal. Nuclear bombs do not win a conventional war but one can destroy a country with it, in the blink of an eye. And here lies a great risk for the rest of the world. What will a dictator do when he realizes that he cannot win the war by conventional means but by other means? That remains the most terrifying question today.

Friday 12 February 2021

Debt cancellation by the ECB. Does it make a difference?

 The recent newspaper publications of a proposal made by more than 100 economists to cancel the government debt held by the European Central Bank has  reignited the discussion about the role of the central bank in supporting the government. The question that many ask themselves is whether this proposal is to be taken seriously. In order to answer this question it is good to go to the basics of fiat money creation. 

When the central bank buys government bonds, say in the context of QE, it substitutes interest bearing government bonds for monetary liabilities, (money base typically taking the form of bank reserves). In the old days these liabilities of the central bank were not remunerated. Since about 10 years, however,  central banks have fallen victim to the lobbying by the banks and have started to remunerate these banks reserves. Nothing in the statutes of the central banks forces them to do so, and they could quickly reverse this policy. In fact, since a couple of years major central banks apply negative interest rates on these bank reserves, indicating how easy it is to reverse the remuneration policies.


At the moment when the central bank buys government bonds, it creates “seigniorage”. This is the monopoly profit arising from the creation of money. This “seigniorage” is transferred to the national government budget in the following way: the government pays interest to the central bank which now holds the bonds, but the central bank returns this interest revenue to the government. Thus, when the central bank buys the government bonds, de facto, the government does not have to pay interest any longer on its outstanding bonds held by the central bank.  The central bank’s purchase of government bonds is therefore equivalent to debt relief granted to the government.


What happens when the government debt held by the central banks is explicitly cancelled? I will argue that economically nothing of substance happens.


As long as the government bonds are on the balance sheet of the ECB bonds do not exist anymore from an economic point  of viewThis is so because, as I argued earlier, when a government bond is on the central bank's balance sheet, a circular flow of interest payments is organized from the national treasury to the central bank and back to the treasury. So, the burden of the debt for the national government has become zero. The central bank can cancel that debt (i.e. set the value equal to zero) thereby stopping the circular flow of interest payment. This would not make a difference for the burden of the debt. Put differently, the profit of the money creation has been transferred to the government at the moment of the purchase of the bonds by the central banks. 


What happens when the bonds that are kept on the balance sheet of the central bank come to maturity? The ECB has promised that it would buy new bonds to replace those that come to maturity. Again, no difference with outright cancellation. Thus, as long as the government bonds remain on the balance sheet of the central bank it does not make a difference from an economic point of view at what value these bonds are recorded on the balance sheet of the central bank. These can be recorded at their face value, their market value ,or they can be given a value of zero (debt cancellation): from an economic view this does not matter because the government bonds on the balance sheet of the central bank cease to exist. 


What matters is the size of liabilities of the central bank. This is the money base that has been created when the bonds were purchased. As long as the money base is kept unchanged, the value given to the government bonds on the balance sheet of the central bank has no economic consequence. If these bonds were to be set equal to zero  (so-called debt cancellation) the counterpart on the liabilities side of the central bank would be a decline in equity (possibly becoming negative). But again, this is of no economic consequence. A central bank issuing fiat money does not need equity. The value of equity on the books of a central bank only has an accounting existence. 


Thus, debt cancellation is fine, but it is equivalent to no-debt cancellation as long as the bonds are held on the balance sheet of the central bank. The problem may arise in the future if inflation surges and if the ECB wants to prevent the inflation rate from exceeding 2%. In that case it will have to sell the bonds, so as to reduce the money base (and ultimately the money stock). If the bonds are still on the balance sheet (because they have not been cancelled) the central bank will sell these. As a result, they will be held by the private sector and  the burden of the debt of the governments will increase because the interest paid on the bonds will go to private holders who do not return it to the treasuries. 


If the bonds have been cancelled they cannot be sold anymore and the central bank will have to reduce the money basein another way. It could issue its own interest-bearing bonds in exchange for the outstanding money base. But this means that the central bank will have to pay interest in the future. As a result, it would transfer less profit to the treasuries. Again, no (or little) difference with outright cancellation.


The conclusion here is that if the ECB wants to keep inflation at 2% it does not make a difference whether it cancels the debt or not today. In that case if the inflation surges beyond 2%, it will have to reduce the amount of outstanding money base by either selling government bonds or issuing its own interest bearing bonds, thereby taking back the seigniorage it granted to the government when it bought the bonds. 


Things would be different if the ECB were to allow more inflation in the future; in other words if it decided that it will do nothing when the inflation exceeds 2%. Then it would not have to sell the bonds (or issue its own bonds). In that case, the higher inflation would reduce the real value of the government debt that is not on the balance sheet of the central bank, and that was issued during the last few years at very low interest rates. The government would gain. But note again that this gain would accrue to the government whether or not the debt was cancelled. 


Who would pay for this inflationary policy? The investors. Nominal interest rates would increase, thereby reducing the price of the long-term bonds that these investors were foolish enough to buy at negative or zero interest rates.  


Two last comments. First, the 100 plus economists proposing debt cancellation have created the illusion that debt cancellation reduces the debt and therefore allows governments, unburdened by old debt, to issue new debt to finance great projects.  I have argued that the debt relief occurs at the moment of the bond purchases by the central bank and not when the central bank puts the value of these bonds equal to zero on its balance sheet. The illusion is to think that you can have debt relief of the same debt twice.


Second, except if at the moment of the debt cancellation governments force the ECB  to cancel its commitment to an inflation target of 2%, the future increases of inflation will necessarily force the ECB to reduce the amount of money base thereby undoing the debt relief it organized when it bought the debt. Thus, as long as the ECB remains committed to its inflation target, explicit debt cancellation is likely to only reduce the debt burden temporarily. Only if the ECB reneges on  its inflation commitment will debt cancellation permanently lower the government debt burden. But somebody will then pay for the inflation tax. One may still argue, however, that some more inflation is worth the price for permanently reducing the government’s debt burden. Maybe this is what the 100-plus economists had in mind.

Thursday 17 December 2020

How to trade when countries insist on sovereignty

 The UK government has become entrenched in its demand for full sovereignty.  Rules about safety, the environmenthealth, workers’ rights, and state subsidies shall be made in Westminster without any interference from Brussels. The UK government insists on the right to diverge from the rules that exist in the internal market. No doubt, that is what sovereignty means. At the same time, however, the UK government also wants to maintain access to the EU internal market under these UK made rules. To use the chicken example: The UK government wants to have the right to decide what the sanitary rules will be for their chickens (for example, they can be washed in chlorine) and at the same time the right to sell those chickens in the EU

The problem with this view is that the EU also is sovereign and therefore has the right to impose tariffs on the import of unwelcome chicken. How can trade be made to work when two partners in a trade deal claim full sovereignty?  

Here is how a full sovereignty model could work. Full sovereignty has two implications. First, it means that each of the two countries decide independently about the laws that will apply in their lands. Thus, all firms (including EU firms) selling in the UK comply to UK laws. Similarly, all firms (including UK firms) selling in the EU comply to EU law.

A second implication of full sovereignty is that each of these two countries decide independently how they will control compliance within their own borders. Firms that do not comply are sanctioned and each country is free to decide about the nature of these sanctions (barring sales, tariffs, etc.). Thus, UK firms selling goods in the EU that do not comply to EU law face these sanctions decided by the EU. The same holds for EU firms selling in the UK. 

Such a trade deal based on full sovereignty would actually be easy to reach quickly. In a full sovereignty model there is no need for complicated joint committees that after long negotiations will have to identify the degree to which rules and regulations in both countries diverge. No need for setting up complicated procedures for settling disputes when divergence is observed. Such committees take a long time to come to decisions. They are time bombs leading to permanent conflicts between the trading partners. Thus, a trade deal based on full sovereignty would be easy to arrive at; it would also be relatively easy to govern in the future, as each country keeps its sovereign power to identify rule divergence and to sanction it.  

Once such a deal is agreed upon, it would be difficult if not impossible, to avoid an asymmetric future development. This asymmetry follows from the fact that the EU internal market is the biggest in the world and much bigger than the UK market. This will lead to what is known as the “Brussels effect”. UK firms will eagerly comply to the EU rules so as to be able to sell in the largest single market in the world. Not doing so, would be punished by the EU and would lead to large losses for many UK firms. For EU-firms the UK market is small and, therefore, being excluded from that market would not be a loss comparable to what UK firms loose when excluded from  the EU internal market. 

This asymmetry will put great pressure on future UK governments to align their laws on EU laws.  Of course, the UK government could initially resist this. This, however, would put UK firms at a competitive disadvantage. They would have to produce for the UK market under UK rules and for the EU market under EU rules. This would raise their production costs. Over time pressure from the UK business sector on the UK government would very likely lead the latter to align its legislation to the EU one. There is no need to try to impose this today. It will come about automatically. 

The previous discussion makes clear that the trade model based on full sovereignty is an evolutionary one. It may ultimately lead to free trade. This will happen when one of the two trading partners, in this case the UK, will recognize that it is futile to continue to pursue full sovereignty. It also shows that free trade can only be achieved if one of the two partners recognizes this. Note that the other partner, in this case the EU, can continue to enjoy full sovereignty and free trade. This “exorbitant privilege” comes from the fact that the EU is by far the larger partner, and thus becomes the rule-maker. This happens as a result of system competition. Firms realize that it is in their interest to take over the rules prevailing in the EU, and then pressure their governments to do likewise. At the end of that tunnel free trade emerges. 

Tuesday 26 February 2019

Green money without inflation

To what extent can the money created by the central bank be used to finance investments in the environment? This is a question that is often asked today. The green activists respond with enthusiasm that the central bank, and in particular the European Central Bank (ECB), should act and stimulate the financing of environmental investments through the printing of money. The ECB has created 2,600 billion euros of new money since 2015 in the context of its quantitative easing (QE) program. All that money has gone to financial institutions that have done very little with it. Why can’t the ECB inject the money into environmental investments instead of pouring it  into the financial sector?
Most traditional economists react with horror. The ECB should not interfere with the environment, they say. The government should do that. If the ECB jumps on the environmental bandwagon, it will be obliged to print too much money. This will fuel inflation in the long run, with terrible consequences. Ultimately, the environment will not be served.
Who is right in this debate? To answer that question, it is good to recall the basics of  money creation by the ECB (or any modern central bank). Money is created by the ECB when that institution buys financial assets in the market. The suppliers of these assets are financial institutions. These then obtain a deposit in euros at the ECB in exchange for relinquishing these financial assets. That is the moment when money is created. This money (deposits) can then be used as their reserve base by the financial institutions to extend loans to companies and households.
There is no limit to the amount of financial assets that the ECB can buy. In principle, the ECB could purchase all existing financial assets (all bonds and shares, for example), but that would increase the money supply in such a way that inflation would increase dramatically. In other words, the value of the money issued by the ECB would fall sharply. To avoid this, the ECB has set a limit: it promises not to let inflation rise above 2%. That imposes a constraint on the amount of money that the ECB can create. So far, the ECB has been successful in maintaining the 2% inflation target. 
There is also no restriction on what types of assets the ECB can buy. Since 2015 when it started its QE-program, the ECB has mainly bought government bonds, but also corporate bonds from financial institutions. The ECB could, however, also purchase bonds issued to finance environmental investments. The only restriction on these purchases (again) is that they do not endanger the 2% inflation target.
What are the options for the ECB? The ECB has bought 2,600 billion of government and corporate bonds since 2015. These purchases have not fueled inflation, which has remained below 2% in the Eurozone. The ECB has now stopped making new purchases. It has announced though that when these government and corporate bonds come to maturity, new bonds will be bought in the market so as to keep the money stock (money base) unchanged. This creates a "window of opportunities" for the ECB. It could replace the old bonds with new "environmental bonds", i.e. bonds that have been issued to finance environmental projects. In doing so, the ECB would not create new money. It would only reorient money flows towards environmental projects. As the total amount of money would remain the same there would be no risk of additional inflation..
A possible objection is the following. If the ECB buys these "environmental bonds", it will be involved in the decision-making process about which environmental investments should have a priority. For example it would have to answer questions such as: How much public and private investments must be made? Should it be renewable energy or nuclear energy? Should the priority be given to public transport? These are all questions that have to be settled by political authorities, and not by the central bank.
One possible way out: The European authorities give a mandate to the European Investment Bank (EIB) to finance, for example, 1000 billion of environmental investments. These political authorities add guidelines for the EIB about environmental priorities. The EIB issues bonds to obtain the resources necessary to fund these investments. This is the moment the ECB can step in by buying the EIB-bonds at a pace dictated by the expiration of the old bonds on its balance sheet. This way the ECB creates “green money” without fueling inflation. At the same time, as the ECB buys EIB bonds, it creates the possibility for the EIB to increase its borrowing in the capital markets without endangering its AAA-status.
The bottom line is that it is perfectly possible for the ECB to use the instrument of money creation to favour environmental investments without endangering price stability. Of course, one could also argue that the ECB could use its monetary instrument to favour other worthwhile projects, e.g. poverty reduction. This is certainly true, and if a majority of the population were to desire this, it should be done. Nevertheless, I am rather reluctant to go in this direction, as it would create the risk that the ECB is loaded with too many social responsibilities that it cannot handle properly. 
That’s why I conclude that given the existential nature of the degradation of the environment, including climate change, the priority should be to use the ECB’s money creation capacity towards the support of environmental projects. This can be done without creating inflation. 

Saturday 8 December 2018

Who should pay for the cost of climate policies?

There should be little doubt that drastic measures are required to protect the planet from environmental catastrophes. But who should pay the bill for these urgent environmental policies? This is the question that is central today and that was placed on the political agenda recently by the “yellow vests” protestations. Many want to save the environment but few want to bear the cost. Yet without resolving this question of who will foot the bill no progress can be made in developing effective climate policies. 
The problem exists at two levels. There is the question on which shoulders of the current generation the greatest burden will be placed. There is also the question of how the costs will be spread between current and future generations. 
The first question is receiving most of the attention today. It is indeed important to design redistributive policies that will ensure that those with the “strongest shoulders” bear a proportionally larger part of the cost of climate policies. This could be achieved by transferring the whole (or part) of the proceeds from the taxes on fossil fuels to those in the lower income brackets. It appears that although this simple principle is easy to formulate, the political conflicts that arise when one wants to apply it are intense.
The second distributional question, the one between the present and future generations is of equal importance. This is the one I want to address here. When we impose extra taxes on households and businesses today to finance environmental policies, we actually ask them to pay the full cost of a policy that will benefit the future generations. Many people resist this today, and then rationalize this resistance by denying the urgency of climate change.  It is therefore important to set out a policy that ensures that the costs are spread between current and future generations in such a way that the distribution of these costs also reflects the distribution of the benefits over time.
There is one policy domain where we can actually apply this distributional rule, and that is public investment. The latter, together with private investments, are essential to transform the economy from the use of fossil fuels to renewable energy sources. Public investments must be made in new energy infrastructure, in public transport, in research and development, and in many other areas. 
The formula that achieves the objective of spreading the costs over time is to finance public investment through the issuance of government bonds. The issue of bonds today provides the financing for the investment project while the payment of interest costs is spread over time. Thus, such a financing distributes the costs of the investment between present and future generations. The latter will enjoy most of the benefits of those investments and will also contribute to their costs. Such a financing also makes it possible for the current generation to be partially relieved of the costs of these investments. This reduces the resistance to costly environmental policies.
Unfortunately the European authorities have put sticks in the wheels. The budgetary rules imposed today by the European Commission prevent the costs of public investment from being spread over time. The rule that the government budget must be (structurally) in balance makes it impossible for public investment to be financed through the issuance of bonds. The reason is that the latter creates a structural deficit in the budget and that is forbidden by the fiscal rule. 
The consequence is that when Eurozone governments want to make environmental investments, they are obliged to increase taxes and/or to reduce other government expenditures (e.g. social security). In other words, they are obliged to force 100% of the costs of these investments to be paid by today’s households and firms. And quite naturally, these resist and rightly so.
The solution to this problem is actually very simple and is sometimes called the “golden rule”. The European authorities should allow public investments to be put into a "capital budget". These may be financed through the issuance of bonds. The European rule of structural balance would then only apply to the ordinary budget consisting of current spending and taxes. Since current spending represents more than 95% of the total budget in most European countries, this would ensure that more than 95% of the budget would be subject to the balanced budget rule. 
The only thing that stands in the way of this solution is the dogma that government debt is always bad. Public debt is indeed bad when it serves to finance consumption. Public debt is good when it serves to make productive investments that help keeping the planet safe from future environmental catastrophes. 
The problem with the dogma that government debt is always bad is that it originates from an obsession that only looks at the liabilities side of the balance sheets of governments. We would never do this when we want to evaluate the financial health of private companies. We would always look at both the asset and liabilities sides to make a judgment about the solvency of these companies. Yet when we make such a judgment about a government we close our eyes for the asset side of its balance sheet; a wholly irrational procedure. When the counterpart of the higher government debt consists of productive assets whose returns exceed the cost of the debt, there is no problem of raising this debt.  The debt can then permanently exceed 60%, or 100% for that matter. It then makes no sense for the European Commission to desperately trying to force public debts into unconditional surrender. 
It is time we shed the dogma that government debt is always bad. We have to shed this dogma to make it possible to massively invest in projects that will prevent climate change from destroying the planet. Such investments can only be made if the costs are shared by current and future generations. 

Tuesday 23 October 2018

The European Commission should accept democratic change in Italy

The Italian budgetary and financial crisis is getting worse. The conflict between the Italian government and the European Commission on the proposed budget is intensifying. It does not seem likely that the Italian government will yield to the demands of the Commission to adjust the budget. This conflict leads investors to continuing to sell Italian government bonds leading to a surge of the yields on these bonds. It has become the major source of upheaval in the Italian government bond market and risks escalating into a full-fledged crisis of the Eurozone.
Time to think again about the budgetary rules that are being applied by the European Commission.
Since the Eurozone’s debt crisis in 2010, the European Commission has seen a dramatic increase in its power to supervise and control national budgets. This development was motivated by the will of the creditor countries to impose budgetary discipline on the debtor countries, such as Greece, Ireland, Spain and Portugal. As a result, the Stability and Growth Pact was strengthened and the power of the European Commission over the budgetary process of the euro zone member states was tightened.
The new responsibilities of the European Commission create a problem of democratic legitimacy. Not in the sense that the Commission's tighter role in the budgetary procedures of the Member States have been achieved in an undemocratic manner. This increased power of the Commission is the result of decisions in the Council of Ministers and in the European Parliament. These are bodies that have been established in a democratic manner and that have decided to give the European Commission more power over national budgetary procedures after applying the majority rule. Formally there is nothing wrong with the legitimacy of the European Commission.
However, I am talking here about political legitimacy. The European Commission can now force countries to increase taxes and reduce expenditures without, however, having to bear the political costs of these decisions. These costs are borne by national governments. This is a model that does not work.
National governments bear the political costs of expenditures and taxes. The risk therefore arises that they will contest the decisions of non-elected officials who do not bear these costs. This has happened a few times in the past. In 2003-04, when their economies were not doing well, the German and French governments collided with the European Commission about their budgets. The European Commission wanted to force these governments to reduce their budget deficits. Both governments refused to do this and the rules were changed "à la tête du client".
Today the Italian government is doing the same. It is a government that has made a number of election promises and wants to implement them now. That has budgetary implications. The European Commission is now trying to force the Italian government to abandon these election promises without having to bear the political cost of doing so. The new Italian government would pay the political price for shredding its election promises. It will not do so, as the French and German governments did not do in 2003-04.
The model of top-down budgetary control does not work in Europe. It does not work because the whole process of decisions on taxes and expenditures still exists at the national level. It is also at the national level that the democratic principle of "no taxation without representation" is implemented. The European Commission's attempts to bring Italy into line today are therefore also attempts to impose exceptions to this democratic principle. It does not work, and fortunately so.
The only way out of this institutional crisis is to go further into political unification. This implies that large parts of the national budget processes would be transferred to the European Parliament. The principle of no taxation without representation would then be applied at the European level. This would raise the democratic legitimacy of the budgetary process to a higher European level.
We are very far from such a political unification today. This means that, at regular intervals, democratically elected national governments will reject the European Commission's attempts to go counter the will of the electorate.
One would hope that the European Commission understands this quandary and that it takes a flexible position, allowing the Italian government to have its budget deficit of 2.6%. It would be a bow of the Commission to the outcome of a democratic change in Italy. It would also take away a major source of upheaval in the Italian government bond market, and the risk that this entails for the Eurozone as a whole. 

Wednesday 11 April 2018

Why Russia is politically and militarily strong while being an economic dwarf

Last week I saw a surprising statistic: the GDP of Russia is of the same order of magnitude as the combined GDP of Belgium and the Netherlands. In 2017 Russian GDP was 1,469 billion dollars (according to the International Monetary Fund). Belgium had a GDP of 491 billion dollars and the Netherlands 824 billion dollars; together $ 1,315 billion. In GDP terms, Russia is only 12% larger than Belgium plus the Netherlands.
This perplexing statistic prompted me to ask why politically Russia weighs so much more in the world than Belgium and the Netherlands, while economically that country is hardly stronger than these two countries bordering the North Sea.
Before answering that question, first some other figures that illustrate how an economic lightweight Russia is. US GDP reached USD 19,362 billion in 2017. With GDP as a yardstick, the US is 13 times bigger than Russia. In the same way, other countries can be compared with Russia. China is economically 8 times larger than Russia; Germany 2.5 times more, France 1.8 more, and the European Union as a whole is 12 times bigger than Russia.
The economic size of a country is one of the most important factors that determines its military and political importance in the world. A large economy is needed to provide the means that gives the country military and political weight in the world. So it is clear: Russia is boxing above its economic weight on the international scene.
The fact that Russia means so little economically implies that the country must exert extraordinary efforts to create a strong military potential. In 2017, Russian military spending  amounted to 61 billion dollars (according to the International Institute of Strategic Studies). The US spent nearly 10 times more, namely $ 603 billion. China spent $ 151 billion on defense. France and Germany together spent 90 billion dollars on defense, 50% more than Russia. And yet all these countries spent a much smaller proportion of their GDP on the military than Russia.
Russia is not a major player in the field of military spending. To have a certain military weight, that country must reserve a much larger share of its GDP for defense than the other countries. To mean something militarily, Russia has to put a heavy burden on its own economy.
I come back to my question: why is it that Russia, which economically is a lightweight, has such an importance politically and militarily? Here is an attempt to answer that question.
First there is the fact that, at the time of the Soviet empire, Russia built up a nuclear arsenal that, together with the USA, gives this country a unique position in the world. This is the position of "Mutually Assured Destruction" (MAD). This means that the country has the capacity to completely destroy the opponent in the event of a nuclear attack on its own territory. No other nuclear power (outside the US) has that capacity today. As long as Russia has such a terrible MAD capacity, it will be politically heavier than its GDP suggests.
Russia is also an important supplier of raw materials, including oil and gas. This gives the country a political lever with regard to Western Europe. It is possible by turning the tap (or threatening to do so) to exert pressure on a number of European countries. However, that effect should not be overestimated. Russia also knows that the use of this weapon will in time encourage European countries to find other sources of supply. The power of Russia is limited in this domain because the country does not have a monopoly in oil and gas.
Finally, and that is my most important point, Russia is powerful because Europe grants that power to Russia. Europe has built up an economic union but not a defense union. The European Union is economically 12 times larger than Russia; A huge potential power. However, this economic power is not converted into military and political power because defense has remained a national matter. By merging their military capabilities, it would be possible for France and Germany to build a credible defense against Russian threats, without having to spend more. The combined military spending of such a Franco-German defense union would be 50% higher than Russian military spending. Enough to offer a counterweight to a Russian dictator whose political and military ambitions in Europe remain unknown.

"Si vis pacem, para bellum" said the Romans. If you want peace, you should prepare the war. Translated to the European situation of today this means that Europe should build a credible defense union. This by itself would reduce the military and political power of Russia.