Rachel Epstein on European Institutions and Economy Amidst Russia’s War in Ukraine

Rachel A Epstein is Professor of International Politics at the Josef Korbel School of International Studies at the University of Denver, where she also serves as the Senior Associate Dean. She is the author of In Pursuit of Liberalism: International Institutions in Postcommunist Europe (Johns Hopkins 2008) and Banking on Markets: The Transformation of Bank-State Ties in Europe and Beyond (Oxford 2017), recipient of the Ed A Hewett award in international political economy.
Thomas Falci '23 interviewed Dr. Rachel A Epstein on on December 2, 2022.
Photograph and biography courtesy of Dr. Rachel A Epstein.

How has the Russian war in Ukraine impacted the unity and cohesiveness of the European Union as an institution?

In many ways the war has enhanced the unity of the EU, and the European Union has successfully projected this image. This is based on the intensity and comprehensiveness of the sanctions regime and the EU’s transition away from Russian gas and oil to other forms of energy. In regards to NATO, the Alliance has shown enormous solidarity with the Ukrainian cause. The country that surprised people the most in terms of shifting its orientation is Germany. The degree to which the Germans have moved away from the completion of Nord Stream II and Russian energy more broadly has been surprising. Overall, this has been impressive, especially the speed at which they made this transition. Moreover, Germany was one of the countries that had long underspent on NATO’s stated goal of 2% of GDP allocated to defense; however, Germany made a renewed commitment to reach that level within the next couple of years. On the one hand, the Germans have been a linchpin for European unity; but on the other hand, there are tensions in all of the steps that Germany has taken thus far. There is intense domestic pressure from some quarters not to take those steps.

If you start looking more closely at EU unity, there are areas in which this unity doesn't look quite as solid. One area in which this came out had to do with Germany's turn away from Russian energy, which particularly led to it bidding up the price for natural gas. This occurred in order to hoard reserves, which all the European countries have done in advance of the coming winter in anticipation of the December 5 oil embargo. All European countries went about trying to increase their energy reserves. However, unlike the sanctions, this was not done in a coordinated fashion. Germany, like everybody else, went out into international markets, such as Norway, the United States, and some African suppliers, to fill their energy deficits. Regardless of what the effects were on energy prices, the Germans just bought what they could, and being wealthy, they didn't particularly care how much they were paying. That is evident disunity. But if we take everything together and understand the larger context of the Russian invasion of Ukraine, I would say, on balance, the war probably enhanced EU unity. But there are some important fissures both between countries and within countries.

In addition to EU collaboration on sanctions, has the war in Ukraine fostered collaboration amongst member states in terms of managing their dependence on Russian energy?

There has been a lot of bilateralism, particularly vis-à-vis the US, given the need to secure supplies over the next six months. The United States does support European unity and supports the European Union at this point in time. President Biden is very committed to NATO. But at the same time, if the Baltic states go to the United States to increase their provisions of liquefied natural gas, the US complies. But the lack of the European Union’s role in some of the foundational economic structures, like with respect to energy markets, means it gives the United States an opening to do bilateral deals. This tends to undermine the integrity of the single market standardization, a coordinated strategy among the Europeans. It's politically messy, and maybe not the most constructive path for the EU.

Have EU states seen increased competition over new sources of energy?

Yes. Not only have they had to compete with each other, but overall supplies have been limited as well. We should be mindful, however, that it is Russia that has limited access of Europeans to their energy supplies. Energy supplies from Russia, up to now, have not been sanctioned. By limiting European access to their energy, Putin and Russia are trying to divide the West and make the West’s aid of Ukraine as costly as possible. This has created a global competitive scramble by Europeans to get their own energy. Yet, the oil embargo that's coming up is a counter example as it shows very intense coordination and negotiation amongst European states. Simultaneously, they have finally agreed to a price cap of $60/barrel for Russian oil, which will significantly affect Russia’s oil transactions around the world, limiting the extent to which Russia could charge another nation more than that. This is because the shipping and insurance industries that transport Russian oil around the world are European dominated. Up to 90% of the oil that comes out of Russia is handled by European insurance and shipping companies. This idea originated with the US Secretary of the Treasury, Janet Yellen, who – given how fast the US embargoed Russian oil – was trying to help the Europeans find a way to limit the extent to which they and the rest of the world were helping Russia fund its war. 

Oil sales from Russia are one of their major sources of revenue. Thus, if the EU can implement it effectively, the $60 cap will affect a huge proportion of Russian oil sales globally, not just to the EU. We should also be mindful, however, that the $60 level was too high according to some EU members, including Poland. The costs of oil production for Russia are much lower, so even a cap of $60 might not cut into Russian revenue as much as some countries would like. The dilemma was how to set the price at a level that wouldn’t allow Russia too many resources to fund the war but that would also not disincentivize Russia from producing. The price cap is designed to avoid creating a damaging price shock to the global economy. So, there is both evidence of competition and evidence of unprecedented coordination, and we'll see whether the latter works in the way that the US Treasury and that the Europeans hope it will.

Has China and India's record of buying discounted Russian energy significantly weakened the impact of European efforts to reduce Russia's ability to wage its war in Ukraine?

Yes, absolutely. There was a summit some months ago where, for the first time, China had expressed to Putin what Putin said were “questions and concerns about the war.” It was right after the Ukrainians launched their surprisingly effective counteroffensive in the Kharkiv region. But putting those questions and concerns aside, Indian and Chinese willingness to continue to buy Russian energy and to not be concerned about Russia's ability to fund its war has very seriously undermined the impact of the sanctions. The IMF made a series of projections about how much the Russian economy would shrink in 2022 back during the beginning stages of the war. Initially they predicted a shrinking of around 14%, but that has since been refined to 3.5%. Part of that has to do with difficulties in calculating the impact because of the now non-convertibility of the ruble. Nobody really knows how much economic activity is taking place in Russia or how to value it. However, India, China, and other buyers of Russian energy around the world definitely hampered the impacted of Western sanctions and helped support the Russian economy.

Has there been any recent change in the strength of the China-Russia relationship?

No, it is still pretty strong, though Xi Jinping is probably very unhappy about the war’s trajectory up to now. Although I am not aware of any changes in the economic relationship, the other way in which China, unfortunately, is very supportive of Russia is by reproducing the Russian propaganda about the sources of the war, the war trajectory, Russia's defensive aims, etc., including the nefarious intentions of the EU, NATO, and the United States.

How have the European Banking and Capital Markets Unions addressed the war and its related economic impacts? Has the war been a test on the strength and functioning of these institutions?

The Capital Markets Union hasn't really gone anywhere since its renewal back in 2015. Initially it attempted to make cross-border raising of funds much easier and to break down national regulatory and supervisory boundaries to diversify funding in Europe. However, an enormous amount of funding from the European financial sector that goes to households, firms, and governments is mediated through banks because they don't have deep capital markets or the range of private equity, venture capital, and bond markets. The Capital Markets Union was intended to diversify funding, and make it cheaper and more accessible, particularly for firms, to access funding. After the financial crisis, which we can say moderated in Europe around 2013 (but wasn’t really resolved until 2017), this effort was put in place, but it hasn't made it anywhere because supervision still remains at the national level. Thus, the capacity for any of those new instruments to make headway in addressing the crisis, expanding channels of funding, raising new funding, raising new volumes, etc., doesn't really exist.

The other prior reform in response to the financial crisis was the European Banking Union, which standardized and centralized oversight of financial institutions. In my work I have looked at the extent to which it tried to sever political relations between national governments in Europe and the banking sector, but that has also not moved very far forward in terms of trans-national bank ownership. The central bank, aside from internal EU transfers, does have some instruments at its disposal to help generate economic activity, but it's in a terrible bind, just like the Federal Reserve, because inflation is running really high and they are considering quantitative tightening to respond to this. For a long time, they were trying to infuse the European economy with cash in order to stimulate it. Now, inflation across the EU is running somewhere between 7 and 21%, depending on the country that we're talking about. Therefore, they need to pull some of that money back, which will be counterproductive to thwarting any negative economic effect from the Russian invasion.

What measures has the European Union been implementing to reduce the risks of an impending recession due to the substantial closing and scaling back of many companies’ operations?

The Europeans are still, as far as I understand, in the process of disseminating COVID recovery funds, and I have been following that particularly in the regions of East and Central Europe. Within the last two years, Hungary, as one of the biggest democratic backsliders, has seen the rule of law mechanism finally being implemented by the EU to give the European Commission the authority to hold back payments for things like COVID recovery relief if the intended recipient is not following the rule of law or protecting democratic institutions. In Orbán’s case in Hungary, for example, many reputable democracy-watching institutions no longer consider that country a democracy. Because of this and the rule of law mechanism, there was a pause on the distribution of COVID Recovery funds to Hungary. Although I don’t know whether the EU or any other organizations have initiated other fund redistribution programs to help countries alleviate the economic impact of the war, they are using national development banks in connection with some European financial institutions to support countries in need. However, this was something that preceded the Russian invasion of Ukraine and was used to jumpstart European economies and, particularly, get them moving more quickly towards green energy. More broadly, however, the energy transition that the Europeans and the Americans have been undertaking – which is something we need to undertake anyway – could be accelerated by Russia’s invasion of Ukraine and the weaning oneself off of Russian energy. The EU Next Generation Program has funding in it for this, but that was funding that was not in reaction to the war. It predated it.

In regards to the European Banking Union, did it have a coordinated response when the war started, in terms of assessing different countries’ exposure to Russia and creating an adequate solution to respond to this?

There was an incident several years ago following the very intense portion of the US financial crisis and as the European debt and currency crisis was unfolding where, at a certain point, one of the big Austrian multinational banking conglomerates, Volksbank, was purchased by state controlled Russian Sberbank. Those European branches went under as a result of Russia’s invasion of Ukraine. Furthermore, there was a coordinated winding down of Sberbank in Croatia and potentially one other EU member state, but it was managed through the European Banking Union's new centralized resolution authority. It was handled extremely well, smoothly, quickly, and without a lot of conflict. However, there were other countries in that region, such as Poland who, from the beginning, were allergic to having Russian investment in their financial sector. Hence, they did not require any sort of coordinated response in this regard. From a more general and auditing perspective, I don’t think there has been a comprehensive effort to get an overview of what the financial exposure to Russia is, as a result of the war.

Have the high levels of foreign domination in finance in many Eastern European countries mattered in their response to the current war in Ukraine?

One example where it probably does matter is that there's very strong Nordic and Scandinavian investment in the banking sectors of the Baltic countries. Take Estonia as an example. Virtually all of its banking sector is owned by the Swedes and the Norwegians. One of the first things that happened after the Russians invaded, was Finland and Sweden, who had historically been neutral even if they had close military cooperative ties with NATO, decided to join the Alliance. They got a formal invitation and they are well on their way to joining. The Baltics’ strategy, from the beginning of their independence, was geared around cultivating Western interests in their fate. Part of this was through encouraging high levels of foreign investment, especially in strategic sectors like banking. Looking at the strategic implications of a banking sector which is almost entirely foreign owned by countries in your geographical region that suffer similar exposure to Russia, that's just a layering on of the kind of interdependencies that leads those Baltic countries to feel safer. That is, they feel safer than they might otherwise feel if they had an economic strategy that was geared more towards self-sufficiency. For the Baltic countries in particular, their location, their history of having been republics, and their deep mistrust of Russia have allowed the foreign bank ownership issue to anchor them and make them less susceptible to Russian intervention.

For these Baltic countries and others in Europe that have banking sectors heavily owned by foreigners, are these foreigners usually European or from other parts of the world?

It's almost entirely European. From the Baltics, down to Croatia, the two countries that have really worked hard in the last decade to reduce foreign ownership is Poland and Hungary. Even in those countries, foreign ownership probably accounts for half of what it is everywhere else. For new EU members, it's probably 60% to 100%, Croatia included. People are ambivalent about it, as the Hungarian and Polish examples show, because if you don't have control over your financial sector, it's harder as a government to politically influence your banks and allocate credit in a way you find strategically useful. On the other hand, it does create these co-dependencies where the Austrians, the Germans, the French, have not just a political interest in protecting those countries, but a very strong economic one too. That's partly by design, from the East European point of view.

Thomas Falci CMC '23Student Journalist

Michielverbeek, CC BY-SA 4.0 <https://creativecommons.org/licenses/by-sa/4.0>, via Wikimedia Commons

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