How to stop aggression

The Russian military invasion of Ukraine has paid off. The Crimea is now part of Russia. Some Eastern regions of Ukraine also risk becoming incorporated into Russia in the near future. Where will this end?

Putin knows that the West is not willing to send soldiers to Ukraine to defend the sovereignty of that country. This gives him a strategic advantage over the West. In addition, it gives him an incentive to continue his aggressive and expansionary policies.  We should therefore not be surprised that new aggressive moves will be initiated elsewhere (in the Baltic countries for example where large Russian minorities live).

Up to now the West has reacted in a feeble way. Financial assets of important Russian individuals have been blocked. Russian companies are prevented from borrowing in financial markets or from transferring assets. These things hurt but insufficiently so. Putin will not be stopped by the West’s half-baked sanctions that have little impact on the Russians economy.

In order to stop aggression a policy must be implemented that will really hurt the Russian economy. This policy can only work if it hurts the Russian revenues from exporting oil and gas. How can this be done without hurting the West?

Today, imports of Russian crude oil account for 34% of total EU imports of crude oil. For gas this percentage is 32%. So we are very dependent on Russia for our energy imports. What about the Russian dependence on us?

The export of crude oil from Russia to the EU now accounts for 84% of total Russian oil exports; the percentage for gas is 80%. Those exports are of great importance for Russia and for the Russian budget. In fact the sales of Russian oil and gas to the EU provide for more than half of all Russian government revenue. Thus it can be said that Russia is more dependent on its exports to the EU than the EU is dependent on Russian oil and gas imports. That creates an opportunity to put pressure on Russia in order to increase the economic cost of aggression.

Here's what I would do if I were European policymaker. I would impose a tax on oil and gas from Russia. Such a tax would have the following effects. First, EU importers would have to pay more for Russian oil and gas and would therefore look for alternative sources of supply. This would reduce the demand for Russian oil and gas. Since the EU is a very big player this effect would be big also. Second, and this follows immediately from the first effect, Russia would have to lower the price of its oil and gas so as to find other buyers in the world. This would create an important shortfall in Russian government revenues, reducing the capacity of Russia to wage wars.

One may object here that this tax would also hurt us because it would raise the price the EU consumers would have to pay for oil and gas. This is not the case, however. The import tax generates revenues for the EU-governments. These revenues could be used to compensate the EU-consumers. Alternatively, they could be used to promote policies aiming at making us less dependent on fossil fuel. Whatever we chose to do with the tax revenue, we would not be harmed by it.

This is an application of what economists call an “optimal tariff”. By the very fact that we are more important for Russia than the other way around, we can exploit our strong economic power and impose an import tax that maximizes our welfare and reduces Russia’s. We should do just that.

Some will argue that Russia could retaliate by stopping the export of oil and gas to the EU. My contention is that Russia would not do this. Such a retaliation would lead a decline of government revenues of more than 50% leading to a paralysis of the Russian government. It would hurt Russia much more than it would hurt the EU.

The European Union has the economic power to confront and to stop Russian aggression. It must use this power.