Mohamed A. El-Erian is the former CEO and co-CIO of PIMCO. He serves on the International Executive Committee of Allianz and is chief economic advisor to the Board of Management, chair of President Obama's Global Development Council and author of the NYT/WSJ bestseller "When Markets Collide."
BRUSSELS -- A common refrain in Europe and the United States these days is that sanctions are a "means to an end" -- namely, use economic and financial pressures to contain and, even reverse Russia's annexation of Crimea. There is a considerable challenge, however. By potentially also pushing Western Europe back into recession, stepped-up sanctions could also be an end in themselves. All of which makes the decision-making process more complex and uncertain at an important geopolitical time.
Western leaders are, as U.S. President Barack Obama said in Brussels yesterday, united in their determination to use sanctions to isolate Russia and impose costs for its annexation of Crimea. And as Jose Manuel Barroso, the president of the European Commission added at his joint appearance with President Obama yesterday, Russia must face the consequences for "unacceptable" actions and behavior. Western leaders have also warned that any additional territorial incursions by Russia would trigger "deeper" economic and financial sanctions. This all makes sense. American and western European leaders are loathe to allow Russia to redefine the map of Eastern Europe, especially unilaterally. But they are not in position to use military force to counter what constitutes, as pointed out by the Financial Times last week, "the first annexation of another European country's territory since the Second World War." Leaders are also right to postulate that deeper sanctions can have quite an economic and financial impact on Russia. Depending on how far they wish to go, they can disrupt cross-border trade, payments and settlements -- all of which would lower living standards in Russia by pushing the economy into recession, fueling inflation, hiking borrowing costs and limiting access to credit. Already the Russian economy is under some pressure, though due less to the sanctions already imposed by the West and more to the private sector's own endogenous behavior. Specifically, as acknowledged this morning by the economy minister, the country is experiencing an "investment pause," a growth slowdown and large capital outflows "nearing" $100 billion. Yet Western European support for imposing deeper sanctions is far from universal or unambiguously enthusiastic. Why? Because of the potential for notable collateral damage. Around 40 percent of Russia's trade is with Western Europe. Even if Russia fails to retaliate by itself imposing counter-sanctions -- an unrealistic assumption -- its weaker economy would quickly translate into lower sales by Western European companies to the world's eighth largest economy, as well as less certain input supplies from there. Under the more likely assumption of Russian sanction retaliation, Western Europe could face a material threat of disruptions in important energy supplies. The region as a whole cannot reorient quickly its energy networks and dependence; and certainly cannot do so without considerable cost. And some countries are very heavily exposed indeed. Yes, deeper sanctions would hurt Russia. . . but likely at a considerable cost for Western Europe, too. Indeed, under most scenarios, a back-and-forth escalation in sanctions would push both Eastern and Western Europe into recession. Realizing this, Russia is comfortable playing the brinkmanship game despite the West's stepped-up threats. For their part, Western leaders cannot ease pressures on Russia, particularly given what has already occurred and the additional massing of troops on Ukraine's eastern and southern borders. All this speaks to two competing realities. On the one hand, it is the economic self-interest of both Russia and Western Europe to allow proper diplomacy to avoid the escalation of a situation reminiscent of classic Cold War confrontations. On the other hand, there seems to be no immediate practical way of decisively diffusing this modern day Cold War crisis, let alone resolve it durably.