Europe starts to use the economics of war.
The West and Russia are not really at war. But it’s not like it’s not at war either. The West’s weapons have helped Ukraine stop Russia’s invasion and even attack back, and the West’s economic sanctions have made it clear that Russian industry is in a lot of trouble.
As a form of retaliation, Russia has put a de facto ban on sending natural gas to Europe. This shows what Vladimir Putin really thinks is happening in the war. In the long run, this will cost a lot: Russia will never again be seen as a reliable trading partner. But Putin seems willing to pay those costs to try to force the West to stop helping Ukraine, which he wouldn’t do if he was sure of the military situation.
In any case, the economic stakes are higher because of the embargo. Six months ago, there was a lot of talk about whether or not Europe could or should stop getting energy from Russia. Well, in a way, Russia has made that decision for Europe.
And it looks like Europe will respond in the same way democracies always do when faced with wartime inflation: by putting in place taxes on windfall profits, price controls, and (probably) rationing.
Before I get to that, let’s make it clear that, at least for now, we’re talking about a problem in Europe. America is having a break from inflation right now. This is mostly because gas prices are going down, but it’s also because shipping costs are going down.
Europe, on the other hand, let itself become very dependent on gas piped in from Russia. This flow has now been cut off for the most part.
It’s important to understand what this cutoff means for the problem. Even though there is a real lack of gas, it shouldn’t be a huge problem. Europe has more gas in storage than usual, and between conservation and other energy sources, it should be able to get through the winter without freezing.
Instead, money and, in the end, people are the main problems. The price of gas in Europe has gone up a lot, and as people look for alternatives, the price of coal, nuclear power, and other forms of energy has also gone up.
This is how things are supposed to work, according to economics textbooks. Europe has a big problem with not having enough energy. Higher prices give everyone a reason to help fix this problem. People will have a reason to turn down their thermostats, add insulation, and put on sweaters. Producers will have a reason to make as much as they can and add more capacity. The best policy is to let markets do their thing.
It is also ridiculously unfair. Energy companies whose prices haven’t gone up will make a lot of money, while many families and some businesses will go bankrupt because of their huge energy bills. They won’t feel better if you tell them that incentives are important for efficiency.
There is also a risk to the whole economy. There are still strong unions in Europe, and some of them will be able to ask for pay raises to make up for the rising cost of living. This could lead to a wage-price spiral that would be hard and expensive to stop.
So it’s not really a good idea to just let energy prices go up.
What about giving families one big check to make up for the higher energy costs? On paper, this might seem like a good idea because people would still have a reason to use less energy. In reality, though, different families can have very different energy bills, even if they make the same amount of money. People who live in poorly insulated homes can’t fix this problem quickly.
So, Europe seems likely to do what democracies always do when there is inflation during a war, which is to try to protect the public from very large price increases and stop people from making a lot of money when the public is in trouble.
President of the European Commission Ursula von der Leyen released a statement on energy on Wednesday. In it, she called for “a mandatory target for reducing electricity use” (i.e., rationing), a “cap on the revenues” of low-cost energy producers (i.e., price controls), and a “solidarity contribution” for fossil fuel producers (i.e., excess profits taxes). It’s important to remember that von der Leyen is not the head of government and doesn’t have much direct power. But the steps she wants to take probably show where Europe is headed.
Will it happen? The details will be very important, of course. One thing that gives us hope is that it’s clear that Europe isn’t going to try to pull a Nixon and try to control inflation while pumping up the economy at the same time. On the contrary, these kinds of wartime controls will come at the same time that the European Central Bank is sharply tightening monetary policy, which could cause a recession.
We’ll see what happens. But we are learning about economic policy in the real world. You can’t and shouldn’t always just let the market go. It would be bad if the emergency controls that Europe seems ready to put in place were to stay in place. But right now, it’s more important to protect families and keep a sense of fairness than it is to follow the rules of textbook market efficiency.