Tag Archives: crimea

Crimean Dilemma: Russia’s Gambit Provides an Interesting Game Theory Experiment

This weekend, Tyler Cowen wrote a great piece in the New York Times discussing how the Crimean crisis can be viewed through a game theory lens. Game theory has been an incredibly framework for understanding foreign affairs since the mid twentieth century, when nobel winning economist and political scientist Thomas Schelling pioneered its use. During the Cold War, game theory provided a very relevant framework for understanding the actions of the US and Russia. Because both countries had nuclear arsenals that could wipe out each other (and take the rest of the globe with them) any threat of nuclear attacks was sure to be mitigated by mutually assured destruction. The threat of nuclear attack, therefore, was not a credible commitment from either country. Now as Russia plays the belligerent role again, it makes sense to turn back to game theory to try to better understand their actions.

First off, Cowen presents four game theory concepts that are relevant to the current situation in Crimea: (1) nuclear deterrence (2) tipping points (3) market deterrence and (4) credibility and consequences. To briefly summarize each of these points:

  1. Nuclear deterrence: This point is simple, but also very worrying – if Ukraine had nuclear weapons, they would have been much more capable of deterring Russia military intervention in the region. In fact, before 1995, Ukraine did indeed have a significant nuclear arsenal after the fall of the Soviet Union but they agreed to give them up after safety assurances from the US and Russia. The fact that Russia reneged on this agreement could make the appeal of attaining nuclear weapons stronger for countries like Iran.
  2. Tipping point: This point I find to be interesting, as it is less obvious than the first. Cowen argues that the world has been relatively peacefully over the last 25 years since the fall of the Soviet Union as new governments have peacefully formed in its wake and we have reach a relative equilibrium. Now, however, most of the situations that are capable of being peacefully resolved have been and we may be on the precipice of a “tipping point” towards more prevalent violent conflict resolution.
  3. Market deterrence: The point here is that financial market punish reckless military actions such as the Crimea gambit. The Russian stock market fell 10.8% the day they invaded Crimea but as the Economist brings up, financial shocks are probably less politically harmful in Russia than the US. Russia has an oligarchical elite that engage in cronyism with the Kremlin – many of whom could have received advanced warning about such a military escapade and positioned themselves to profit. On this point I slightly disagree with Cowen – while Russia is certainly exposed to financial markets more than they were during the Cold War, Putin can be reasonably sure that short term fluctuations in markets will not do significant political harm.
  4. Credibility and consequences: I believe that this is probably the most important issue raised. The question Cowen raises is how much credibility does the US lose by not acting to protect Ukraine as we pledged to do in the 1995 agreement? American self interests are not really on the line – Ukraine is more in Russia’s traditional sphere of influence and has limited economic and political ties to the US. Therefore any commitment to intervene may not be very credible. The consequences of this will be most interesting in Asia, where commitments to intervene for small Pacific countries that could one day face Chinese hostilities may be seen as not credible after the US response to Crimea.

Overall, I think Cowen has brought up several interesting points which have given me a different perspective when looking at this situation. At this point, it looks like the potential to be a prisoners dilemma type of scenario. While Russia and the US would be best off on the whole if they could cooperate to come to a reasonable compromise, the payoff of Russian defection is very high (they get to annex Crimea). They do not believe the US will credibly retaliate forcefully, which would be the worst outcome for everyone, so they defect and gain Crimea as a result. It will be interesting to see what the consequences of this repeated game are for both sides.

(Revised) Russia Hurt by Ukraine Crisis

The crisis in Ukraine is far from over, even though the major protests have ended and former president, Viktor F. Yanukovych, has fled the country. Yanukovych still claims to be President, but is essentially out of the picture for now. But the troubles in Ukraine, and particularly the  succession of Crimea, are putting a damper on the Russian economy. For those not familiar with the situation, Crimea is a peninsular, autonomous parliamentary region in southern Ukraine which consists of predominantly-Russian peoples. It became a part of Ukraine when it gained independence with the breakup of the Soviet Union in 1991. Crimea mostly sympathizes with Russia, and the elections last Sunday decided they would join Russia.

So what if Crimea wants to join Russia, why should the world care? Well for one thing, Ukraine does not want to lose Crimea. And since the EU and the United States are sympathetic to the new Ukraine (planning to give $15 billion in loans, grants, and investments), these countries are condemning Russia’s push towards the acquisition of Crimea. The economic implications imply that trade with- and investment in- Russia will be reduced, and the effects will be felt in the Ukraine, the EU, the US, but mostly in Russia.

According to an article from the Financial Times, Russian companies are pulling billions out of western banks, in fear that the US will place sanctions over the Crimean crisis and that this could lead to an asset freeze. The fear alone, something we are well aware of in economic expectations, has had significant impacts on the Russian economy. The yield on Russia’s 10-year government bonds increased from 8% in January, to 9.7% on Friday. Also, the rouble is trading for 36.7 for a dollar (almost at its weakest rate in history). Russia’s top 10 billionaires are suspected to have lost $6.6 billion in their combined net worth, over this past week alone. “Strobe Talbott, president of the Brookings Institution, who served in the State Department under Bill Clinton, said: “The irony is that the Russian banking sector has made quite a lot of progress in plugging into the global system. That means it is vulnerable, and a good lever for applying pressure.”” Evidently, the Russian banking sector is going to suffer deeply – not only from possible sanctions, but from the expectations surrounding them.

Europe and the US are expected to impose travel bans and asset freezes on certain individuals close to Russian President Vladimir Putin, at first. And Russia is thus expected to respond with the same restrictions. Investors have already pulled $33 billion out of Russia in January and February, and that figure is expected to near $55 billion by the end of March, according to Russian investment bank Renaissance Capital. On top of this, Russia will face costs to maintain Crimea: estimates are that it will have to commit to roughly $10 billion per year over the next five years in order to build infrastructure, support pensions and pay social benefits to the region’s 2 million citizens.

Russia will experience a significant effect from all of this, as well as the EU and US. But effects on western countries will be miniscule compared to those in Russia. The EU’s ex ports to Russia account for 1% of EU GDP, while Russian exports to the EU are worth nearly 15% of Russian GDP. Germany has significant investments in Russia, and its impact is expected to be at most 0.1% to 0.2% on economic growth, over the next 12 months. This would be rather insignificant for the European recovery. The US is expected to see similar effects.

Thus, it is important to consider the vast implications of the crisis in Ukraine. Mostly, we should expect to see the Russian economy suffer after the Crimean decision to join Russia. However, the long-term effects are unclear. I suspect tensions will ease within a year, and sanctions will be reduced, allowing trade and investment to increase close to current levels. So far, Crimea has voted in favor of joining Russia, and the US has responded with sanctions on individuals close to Putin, and tensions (specifically between Russia and Ukraine) continue – as expected. Hopefully, tensions will ease soon, but I don’t see Crimea being returned to the Ukraine in the near future, making it a difficult situation all around. In terms of the benefits to Russia, I see them as completely outweighed by the costs, in this annexation of Crimea.

Stocks Don’t React to Crimea News

After the news about Crimea’s vote to leave Ukraine and join Russia, there was the possibility of seeing a reaction in the stock market. However, people are relieved to see that the U.S. stock market rose, despite potentially-problematic political tensions with Russia. It seems like for now, the situation is not severe enough to prompt a significant disruption in the market. A Wall Street Journal article explains that “the outcome matched market participants’ expectations… prompting investors to unwind cautious bets meant to protect against potential market-spooking headlines. Looking ahead, investors are awaiting details of any economic penalties to be imposed on Russia by Western leaders, who have said a Russian annexation of Crimea would be illegal.” This morning, the official sanctions were announced by President Obama: “sanctions on specific individuals responsible for undermining the sovereignty, territorial integrity and government of Ukraine…second, sanctions on Russian officials — entities operating in the arms sector in Russia and individuals who provide material support to senior officials of the Russian government.”

The sanctions are very limited, only concerning specific individuals tied to Putin’s government. So the stock market, in ignoring the Crimea news, is not likely to be affected by this announcement either. “U.S. stocks climbed, rebounding after last week’s selloff, as investors took Crimea’s widely expected vote to secede from Ukraine in stride.” The Dow Jones Industrial Average rose 192 points, or 1.2%, to 16259 in today’s trading. The S&P 500 rose 18 points, or 1%, to 1860. The Nasdaq Composite Index also rose 45 points, or 1.1%, to 4290.

And good indicators continue to pronounce themselves in favor of recovery. Federal Reserve data showed U.S. industrial production rose 0.6% in February (which was higher than expected). Capacity utilization increased to 78.8% (a slight, but important change). Alan Gayle, director of asset allocation at RidgeWorth Investments, says that the data supports the notion that U.S. economic growth is still on track, and a series of weak points around the start of the year were mostly about severe winter weather than a falter on economic recovery.

Thus, the good news today is two-fold: stocks rose despite the news from Crimea (which is a good sign persistent, stable recovery) and the recovery seems to be strong. At this point, growth is slow but steady – which may be exactly what the economy needs. If we saw excessively-fast growth and stimulus, we would be more concerned with inflation than the economic recovery. It is best to focus on this kind of current growth, which seems to be relatively stable.

Conflict in Crimea: Impact on the EU Energy Market in the Short and Long Term

The recent conflict in Ukraine took an interesting turn today when the Crimean parliament formally applied to join Russia and separate from Ukraine. Many facets of the Russian, Ukrainian, and global economies have been affected by the crisis in Ukraine, but one industry that has gotten a lot of attention in particular is energy, and for good reason. Given the EU’s dependence on Russian natural gas (a majority of which is supplied to the EU through the Brotherhood pipeline that runs through Ukraine), the quickly escalating tension between western leaders and Mr. Putin have raised concerns about the supply and price of natural gas. A sudden jump in gas prices would hurt households and companies across the EU, but as a recent Economist Intelligence Unit report, “Ukraine: The energy impacts,” indicates, the energy risks for the EU are less troubling than they first appear.

The report reveals that EU reliance on Russian natural gas has steadily declined since the mid 1990’s. Due to past pricing disputes with Russia in 2006 and 2009 the EU has made a strong effort to substitute its Russian natural gas consumption with alternatives such as liquefied natural gas, coal, and renewable energy. Furthermore, the EU has been looking to other countries for its natural gas needs. Although Russia still accounts for roughly 30 percent of the EU imports of natural gas, Norway and Algeria are starting to play a larger role. As seen by the following bar graph showing the distribution of EU natural gas imports in 2011 and 2012, Russia’s market share is decreasing:

                                                            Distribution of EU Natural Gas Imports by Country 2011-12

Although gas and alternative fuel prices may rise slightly, the report emphasizes that the short term effects on the EU’s natural gas supply will not be too worrisome due to three main reasons:

  1. The Existence of Other Pipelines from Russia to the EU: The Nord Stream pipeline through the Baltic Sea to Germany and the Yamal pipeline through Poland and Belarus offer the EU alternative methods of importing gas from Russia, making the threat of a pipeline shutdown in Ukraine less scary. Mr. Putin could still, in principle, cut off or tighten supply to the EU as a political tool, but as the next reason explains, he is unlikely to do so.
  2. Russia’s Dependence on EU Natural Gas Demand: The EU is one of the largest buyers of Russia’s natural gas, and therefore significantly contributes to Russian GDP (about 3% of total output). Mr. Putin is unlikely to cut off or tighten supply for too long because the costs of such an action would not outweigh the possible political gains.
  3. Timing (End of a Mild Winter): Because the crisis comes at the end of a comparatively mild European winter, the EU has had time to stockpile significant natural gas reserves, which could, by themselves, be used to supply the region for a two months at least.

The long term effects are likely to involve an EU effort to rely even less on Russian natural gas. Some potential effects that the report mentions and I have brainstormed are:

  1. Increased EU Demand for Norwegian and Algerian Gas: I would argue that EU demand for Norwegian gas especially will increase because it provides the EU an effective hedge from political risk. Although Norway is not a part of the EU, it is very closely associated with it and is much less likely to stir up political conflict compared to its larger competitor in the East.
  2. Increased EU Demand for LNG: Liquefied natural gas is the EU’s most readily available alternative to Russian natural gas, so it is probable that it will start importing more of it. It is even possible that the U.S. shale gas industry stands to benefit from this shift, but this is only realistic in the very long term because building the infrastructure necessary to export LNG to Europe would take a while.