Economics as a Weapon of War: Ukraine, China and Beyond


“Apply this economic, peaceful, silent, deadly remedy and there will be no need for force. It is a terrible remedy. It does not cost a life outside of the nation boycotted, but it brings a pressure upon that nation.” — Woodrow Wilson

Economics has always played a role in wars. In the American Revolution, blockades were used to prevent nations from trading, in order to cause shortages and prevent treasuries from replenishing their gold reserves. In the Ukraine war, however, economics has played an especially significant role, allowing the United States and its allies to take on Russia without losing a single life, and inflict more damage than carpet-bombing could, albeit more slowly. Moving forward, it seems that economics will play a greater role in future wars. China is Washington’s other major adversary, so Beijing is most likely watching what unfurls in Russia. Xi Jinping is surely asking himself if China could withstand similar sanctions, if they were imposed in response to an attack on Taiwan.

Since the invasion of Ukraine, the U.S. and its allies have levied some 11,000 sanctions against Russia. The economic aspect of this war has been dubbed the third front by Matthew Schmidt, a former lecturer at the U.S. Command General Staff College. Although sanctions by themselves are not expected to defeat Russia, they had a negative impact on the country’s economy last year and are expected to have an even greater impact this year.

The first sanctions imposed by the U.S., shortly after the war began, prevented the sale of most commodities and technology to Russia. Western banks and companies were prohibited from transactions with many of Russia’s largest banks. Numerous Russian financial entities were removed from the SWIFT international payment system. Financial institutions were no longer permitted to extend credit to certain major Russian corporations. The Kremlin’s foreign currency reserves, held in Western banks, were frozen. And trading in Russian government bonds was banned.

In the early stages of the invasion, the World Bank and other authorities forecast that the Russian economy would contract by 8 to 10 percent. The Russian central bank, however, moved quickly to insulate the economy and stabilize the currency. The government nationalized assets of foreign companies that left country. Russian banks increased interest rates to 20 percent. Restrictions were placed on the conversion of rubles into dollars, while companies were forced to convert 80 percent of their dollar holdings to rubles. And although the currency took an initial dive, by summer it had recovered.

An unintended consequence on sanctions preventing exports to Russia was that they prevented capital from leaving the country. With export revenues rising from skyrocketing oil prices and little money being spent on imports, by November, Russia had developed a major trade surplus. Oil and gas revenues were up 28 percent, while the GDP continued to grow.

In December, this all changed, when Russia’s balance sheet was hit with a trifecta of bad news. Oil prices went into sharp decline, the EU imposed an oil-price cap, and Moscow completed its accounting for its war expenses. Suddenly, GDP growth was negative 2.1 percent in 2022.

In 2021, Russia provided 17.5 percent of the world’s oil, 47 percent of its palladium, “16.7 percent of nickel, 13 percent of aluminum, and almost a quarter of potash fertilizers.” Restrictions of these raw material exports would be devasting for the global economy, and so the harshest sanctions were placed on less crucial commodities: steel, coal, and processed wood exported to Europe. Combined, they made up just 11.7 percent of Russia’s exports. Consequently, the effect was not as damaging as it could have been. On the other hand, these restrictions put tremendous economic pressure on specific regions of Russia where the mines, processing, and manufacturing plants are located.

Moscow mitigated the impact on the domestic economy by increasing public expenditure by 32 percent. During 2022, the Kremlin increased planned budgetary spending by $113 billion, roughly half of which went to the military. The rest of the money went to increased social payments, including aid to families with children. This spending created a budget deficit of about $50 billion which was covered by withdrawals from the National Wealth Fund.

The year ended not as badly for Russia as had been predicted by Western experts, but much worse than the Kremlin had hoped. New car production decreased 59 percent, while airplane production is down at least 25 percent. Only about 30 percent of machine tools are manufactured in Russia, and the machine building industry is believed to have contracted by 10 percent last year. The pharmaceutical industry is roughly 80 percent dependent on imported raw materials. Consequently, medicines are in short supply. Spare parts are running out, and as repairs are needed more and more vehicles and machines will have to be taken out of commission. Western restrictions on the sale of dual-use technology have impacted the manufacture of military equipment. For now, Russia may still be using up its Soviet-era surplus, but once that runs out, it will be difficult to manufacture more modern weapons and equipment. GPS modules and microchips are among the items which can no longer be sold to Russia and which they will find it hard to manufacture themselves. Unmanned aerial vehicles (UAVs), which have played a large role in the Ukraine war, will be difficult to build without Western technological inputs. Drones, such as the KUB-BLA “kamikaze” UAV, the E95M, and the Orlan-10 UAV, all rely on imported technology.

Oil production is up 7 percent since the beginning of the year, but this may be due to increased demand from the Russian military. However, with reduced exports to Europe, production is expected to decrease by 7 to 8 percent by the end of 2023. The European oil price cap is in place, meaning that no oil can be sold to Europe for more than $60 per barrel. European and allied insurers and merchant vessels will not carry Russian oil which is priced higher than $60. Since the cap was put in place in December 2022, Russian oil revenues have fallen by 17 percent. Russia is now relegated to trading with countries not participating in the price cap, India and China being the largest buyers. To attract buyers, Russian oil has to be priced below the market price for oil. At the same time, global gas and oil prices have decreased by 43 percent since their 2022 peak. Now, not only does Russia have to sell below this lower global price, but in order to bypass sanctions, gas and oil have to travel the long way round to India. This adds one month and about $10 per barrel to the cost.

According to most analysts, the economy is expected to decline 2.3 percent. However, this contraction could be worse if Russia does not find additional markets for its exports. Professor Jeffrey Sonnenfeld from Yale School of Management told Deutsche Welle that much of the data used by the IMF, World Bank, and other international organizations to make their predictions is provided by the Kremlin. His independent research on the state of Russia’s economy suggests that the picture is much worse than that believed by many observers. One point he made is that there is no market for rubles, not even a black market. Consequently, there can be no price for rubles. The official rate is 75.4 rubles to the dollar, but since none of the exchanges are accepting rubles, where does this price exist?

The Moscow Stock Exchange (MOEX) is down 38 percent since last year. Sonnenfeld speculates that the only reason it has not declined more is because foreigners are not allowed to sell their holdings. In reaction to the restrictions put on sales by foreigners, the U.K. revoked MOEX’s status as a recognized exchange.

The retail sector is down by at least 6.6 percent overall while the non-food sector is down 15 percent. But it is important to remember that these numbers are nominal sales revenues, so they are based on higher prices resulting from inflation. Accordingly, the total quantity of goods purchased and consumed by the average Russian has declined by even more than the sales figures suggest — and these numbers are expected to get worse.

Between the oil price cap and the additional cost of shipping oil all the way to India, Russia is barely breaking even. Consequently, Sonnenfeld believes that there is very little money coming in, and a lot of money is being spent on the war and on job creation, as the public sector has absorbed people who were made redundant as a result of the slowing economy. Public sector employment has increased by 300,000 since the war started, not counting the 300,000 called up to military service.

In the second year of the war, Russian defense spending is expected to reach 5 percent of GDP, while the deficit is expected to be 1.5 percentage points above Moscow’s projections of 2.3 percent. The 2023 budget deficit could be covered by withdrawals from the National Wealth Fund, but the Kremlin has already spent about a quarter of the fund, with only $87.2 billion remaining in liquid assets. With the international sale of Russian government bonds prohibited, raising taxes and cutting social programs may be the only options left. Last year, the government increased social spending, to placate the populace and make them more amenable to the war. Reversing those policies may cause a public backlash.

Samuel Charap, a senior political scientist at the RAND Corporation and a former senior advisor at the U.S. State Department, said he believes that Russia has been able to withstand sanctions so far, because they have been imposed gradually, over a period of a year, providing Moscow with time to adjust. According to Brad Bowman, senior director of the Center on Military and Political Power at the Foundation for Defense of Democracies, sanctions have to be comprehensive and consistent; otherwise, if one entity is sanctioned, business will just shift to another. A black market is helping Russia bypass sanctions, with semiconductors coming in from Turkey, China, and Hong Kong. Mysterious ghost ships, with hidden registrations and origins, having been transporting Russian oil. And China is suspected of planning to provide Moscow with weapons.

In his opening statement at the U.S. Senate Committee on Banking, Housing, and Urban Affairs hearing on national security, Ranking Member Tim Scott (R-S.C.) said that existing, secondary sanctions need to be enforced against China, India, Iran, Turkey, and other countries which are known to be supporting the Russian economy.

Rachel Ziemba, an adjunct senior fellow for economics and security at the Center for a New American Security, said that sanctions were never intended to be a “silver bullet” destroying Russia and ending the war. They were meant to weaken Russia, in combination with military action on the ground. The sanctions on Russia will not cause an outright collapse but will severely limit GDP growth and set the country back many years in terms of technological development. A final victory, however, will depend on the U.S. and its allies continuing to support Ukraine.

This war can be seen as a battle of economic attrition between Russia and Ukraine. Whichever country collapses first will lose. Ukraine’s economy contracted by 30.4 percent in the first year of the war. Around 8 million people who have fled the country, while 5.4 million are internally displaced. The electricity grids are threatened. Manufacturing is in contraction, plagued by uncertain logistics and transportation. There is no way that Kyiv could resurrect the economy, much less feed the entire population, without help from outside. And this brings us to the other aspect of the economic war. At the same time that the Western allies are breaking the Russian economy, they are propping up Ukraine. U.S. Treasury Secretary Janet Yellen stated that U.S. financial support was necessary to keep the Ukrainian government afloat. So far, the U.S. has provided at least $25 billion in assistance, while President Joe Biden has asked congress to approve more. Yuliya Pavytska, an economic analyst at the Kyiv School of Economics, confirmed that the Ukrainian economy was dependent on aid from the West, but she defiantly stated that it would not collapse.

The economic war in Ukraine serves as a warning to China’s Xi Jinping. Although this second year of sanctions will most likely be more damaging to Russia, the reason Russia has not collapsed yet is because it has unique advantages which China lacks. First off, Russia’s debt-to-GDP ratio was extremely low, less than 20 percent, whereas China’s debt is around 300 percent of GDP. Next, much of China’s exports are manufactured by foreign companies in China. If foreign companies exited China, as they did in Russia, this would severely slash China’s manufacturing base, exports, and GDP. For example, if Nike pulled out of China tomorrow, the factory would still be there and a Chinese company could take it over, but what product would they manufacture and would the world agree to buy that product, as opposed to Nike products manufactured in India,Vietnam, or Indonesia?

Sanctions on Russian imports were slow to be applied to Russia’s most important source of revenue, oil and gas. Europe could do without Russian manufactured goods, but was dependent on Russian energy. China’s exports, however, mostly consist of consumer products which could be produced elsewhere. Even essential products from China, like pharmaceuticals, or essential services, such as processing of raw materials, can be done elsewhere. When the supplies from China are cut off, the price will increase, making manufacturing anywhere, even in the U.S. or Europe, more attractive.

The first round of sanctions prevented Russia from importing foreign products and raw materials. And while these restrictions are making it more difficult for Russia to service and repair its existing infrastructure and equipment, Russia, unlike China, is a resource-rich country. Raw materials account for over 25 percent of China’s total imports, while intermediate goods account for 19.25 percent. Without these, China’s manufacturing sector would grind to a halt.

The blueprint for economic war was developed over a period of centuries. The Ukraine war is serving as a lab test. The allies will adjust and tweak the technique, making it one of the most powerful weapons to be deployed in future wars.

Antonio Graceffo
Antonio Graceffo
Antonio Graceffo, PhD. China-MBA, is a China economic-analyst who has spent over 20 years in Asia, including 7 in China, and 3 in Mongolia, where he teaches economics at the American university. He is a graduate of Shanghai University of Sport and Antai College of Economics & Management, Shanghai Jiao Tong University. Additionally, he conducted three years of post-doctoral studies at School of Economics Shanghai University, focusing on U.S.-China trade, and currently studies national security at the American Military University. He is the author of 5 books about China, including Beyond the Belt and Road: China’s Global Economic Expansion and The Wushu Doctor. His writing has appeared in The South China Morning Post, The Diplomat, Jamestown Foundation China Brief, Lowy Institute China Brief, Penthouse, and others. He is a frequent guest on various TV shows, providing China commentary on NTD network in the United States.