Russia-Ukraine Crisis and Deglobalization

AP/Russian Defense Ministry Press Service

In this image taken from video and released by Russian Defense Ministry Press Service, A Russian rocket launcher fires during military drills near Orenburg in the Urals, Russia, Thursday, Dec. 16, 2021. Amid a buildup of Russian troops near Ukraine, Moscow has denied planning an attack on Ukraine but urged the U.S. and its allies to provide a binding pledge that NATO won't expand to Ukraine and won't deploy military assets there _ a demand rejected by the West.

Within a week, Russia's invasion of Ukraine has changed the global economy as we knew it. Globalization allowed countries in the world to share labor to reduce global production costs.

Western allies have imposed economic sanctions as a strategy to isolate Russia from the global economy. In mathematics is the term stable local equilibrium, but it will not necessarily survive dynamically if there is a large enough shock to the system (Chiang, 2004).

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The book The Great Reversal (Goodhart and Pradhan, 2019) says that there is no party that will not end. It conveys the message that deglobalization, with all its derivatives, such as inflation, slowing productivity growth, and unemployment, will return as a new balance.

Although not a few failed, many countries have taken advantage of globalization to achieve high growth, inflation control, and low unemployment.

In other words, globalization is most likely a phenomenon of multiple equilibriums. Accelerated globalization occurred after the Cold War between the countries of the Western and Eastern blocs with the collapse of the Soviet Union in 1990. Although not a few failed, many countries have taken advantage of globalization to achieve high growth, inflation control, and low unemployment.

The US-China trade war during the Trump administration, the Covid-19 pandemic, and the Russia-Ukraine conflict that began on 25 Feb. 2022 have caused the world to slide back towards deglobalization.

Another thing to watch out for is the point of no return. The ongoing conflict carries a risk of causing a direct clash between the world’s superpowers that could lead to a situation of MAD (mutual assured destruction), a term from the Cold War of the 1950s to the 1980s. The system of alliance has brought many countries that actually have no business directly into the conflict.

JUAN BARRETO

Members of the Ukrainian community take part in a demonstration against the Russian invasion in Ukraine in front of the Russian Embassy in Bogota, on March 5, 2022.

Barbara Tuchman, a two-time Pulitzer Prize winner, in her book The Gun of August, recounts the situation in the first months of World War I in 1914. This risk seems to be recognized by the countries in the NATO alliance as well. Therefore, one by one, they stated publicly that they would not deploy troops to Ukraine.

For Indonesia, global inflation is transmitting to the domestic economy through the prices of oil and gas, agricultural commodities, including agribusiness as well as the various raw, auxiliary, and semi-finished goods used by industry.

The conflict has added to already existing global inflationary pressures, as Russia is the world's largest producer of fossil energy with a world market share of roughly 10 percent for crude oil and 17 percent for natural gas.

International commodity futures traders have anticipated the geopolitical risk. The price of West Texas Intermediate (WTI) crude oil is one example. The price movement from US$68 to $80 per barrel was based on perceptions of the world's economic recovery. Meanwhile, the price movement from $80 to $90 was a consequence of the geopolitical risk premium due to the increase in preinvasion tensions in Ukraine, while the price movement from $90 to $110 was due to the outbreak of armed conflict.

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The impact on Indonesia can be seen in the difference in the prices of nonsubsidized fuel and liquefied petroleum gas (LPG), which have encouraged substitution of subsidized products. The next biggest impact is on global food prices. Ukraine is a grain producer with a 25 percent market share, dubbed the “world's breadbasket”. Together with Russia, it produces 30 percent of the world's supply of grain.

As a result of the conflict and economic sanctions, wheat prices have increased to a record high since 2008. A week after the invasion, the price of wheat had skyrocketed 40 percent. The hardest hit are countries that rely on wheat as their main food source, especially those in northern Africa.

The price increase has also affected other food products, either through substitution or complementary effects or due to speculation on world commodity futures exchanges.

This situation full of uncertainty has led to food hoarding. Several countries with staple foods made from wheat have increased their wheat purchases on both the spot and future markets to strengthen their strategic reserves. The price increase has also affected other food products, either through substitution or complementary effects or due to speculation on world commodity futures exchanges.

Wheat is also used for animal feed. The price increase has encouraged soybean substitution so that soybean prices have also increased. The recent increase in the price of beef and soybeans, the raw material for tofu and tempeh, is the result of the geopolitical situation in Europe. In addition, wheat and soybeans are also used as feedstock for bioenergy, thereby adding to the complexity of the transition to renewable energy.

REUTERS/YANNIS BEHRAKIS

A Russian soldier (L) guides a Ukranian tank which will be loaded onto a train in northern Crimea March 27, 2014.

With the global inflationary pressures above, Statistics Indonesia (BPS) data show that Indonesia's inflation remained low in February with a deflation of 0.02 percent. However, with the economy recovering, the approaching Ramadhan fasting month and Idul Fitri, as well as global inflation due to the conflict in Europe, inflation is expected to be closer to Indonesia's long-term inflation projection of around 3 percent.

Implications

The wise phrase “crisis begets reform” is relevant in addressing the geopolitical crisis in Europe. In the past, Indonesia used it to carry out structural transformation.

The oil price hike in the 1970s due to conflicts in the Middle East resulted in restructuring the economy towards the non-oil and gas sector, such as labor-intensive manufacturing and services.

Borrowing the term game theory, in a situation of transition in which the end game is not yet clear, the optimal policy is a mixed strategy.

The ongoing pandemic and the geopolitical crisis in Europe have moved the world further towards deglobalization. However, it is not yet known whether this is a permanent or temporary phenomenon. Borrowing the term game theory, in a situation of transition in which the end game is not yet clear, the optimal policy is a mixed strategy.

Indonesia cannot turn away from the global economy, as the pandemic has provided an opportunity to delve deeper into the international supply chain (exports). At the same time, Indonesia must maintain growth and control inflation by strengthening domestic production by focusing on agriculture and its derivative industries as well as energy through the use of renewable energy.

As can be seen from the pattern of recovery from the first quarter to the fourth quarter of 2021 with discipline in implementing the health protocols, from the demand side, Indonesia can take advantage of the middle class whose spending pattern has shifted increasingly to the mobility sector, such as trade, tourism, accommodation, and family leisure because of the pandemic. All these have become a source of growth for micro, small and medium enterprise (MSMEs).

KOMPAS/HERU SRI KUMORO

Ari Kuncoro

Ari Kuncoro,Rector of University of Indonesia

(This article was translated by Hendarsyah Tarmizi).