Opinion: If Europe and the United States want to win the war in Ukraine, they must enlist their economies in the fight

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NEW YORK (Project Syndicate) — On the political front, the G-7 and like-minded countries around the world have taken a war footing to stop Russian aggression. Russian President Vladimir Putin violated the most fundamental principle of international law by launching an unprovoked attack on another member of the United Nations, an institution created explicitly to prevent such aggression.

The dangers of appeasement should be obvious. Even a little empathy should make us shiver in horror at the thought of having to live under Putin’s rule.

It is a special war. While Putin has described his plan as a confrontation with the entire West, only the Ukrainians are leading all the fighting and bearing the full brunt of Russian attacks on civilians and civilian infrastructure. Meanwhile, Europe and America provided economic and military assistance, and the rest of the world dealt with the fallout of the war, including higher CL00 energy,
-0.27%
and food W00,
-0.09%
prices.

Wars inevitably cause shortages and generate windfall gains for some at the expense of others. Historically, war profiteers have usually been executed. But today they include many energy producers and traders who, rather than being driven to the gallows, should be subject to a windfall tax.

But it is a mistake to think that war can be won with a peacetime economy. No country has ever prevailed in a serious war by leaving the markets alone. Markets are simply moving too slowly for the kind of major structural changes that are needed. That’s why the United States passed the Defense Production Act, which was enacted in 1950 and recently invoked in the “war” against COVID-19, and again to address a critical shortage of infant formula.

Footage shows police firing a drone in Kyiv after Russia targeted the city with a new wave of strikes, Ukrainian officials say. Rescuers pulled people from the rubble of a residential building damaged by the attack. Photo: Yasuyoshi Chiba/AFP/Getty Images

Extraordinary profits

Wars inevitably cause shortages and generate windfall gains for some at the expense of others. Historically, war profiteers have usually been executed. But today they include many energy producers and traders who, rather than being driven to the gallows, should be subject to a windfall tax.

The European Union has proposed such a measure, but it would come too late, and it is too weak and too narrow for the challenge at hand. Likewise, while several members of Congress have introduced bills to tax Big Oil’s superprofits, the Biden administration has so far remained steadfast on the issue.

This is understandable, given that President Joe Biden has been busy garnering support for landmark achievements such as the Cut Inflation Act and the CHIPS Act. Moreover, in seeking the cooperation of the private sector to limit price increases, he tried hard not to appear “anti-business”.

Taxing windfall profits and using the proceeds to finance necessary war expenditures and support for those hit by high prices is not anti-business; it is responsible governance in times of war.

But taxing windfall profits and using the profits to finance necessary war spending and support for those hit by high prices is not anti-business; it is responsible wartime governance that is necessary to maintain popular support for the war effort. Such temporary taxes do not harm investment or employment, and there is nothing unfair about imposing windfall gains that companies have done nothing to deserve. (Also, more generally, corporate income taxes are not distorting because costs, including capital, are deductible.)

Inappropriate marginal cost pricing in times of war

Even more comprehensive measures are needed in Europe, where the current electricity market was not designed to cope with wartime conditions. Instead, it follows the principle of marginal cost pricing. This means that the price of electricity reflects the most expensive source of generation needed to meet current demand. As gas prices soared, marginal costs rose well above average costs. The cost of renewable energies, for example, has changed little.

Thus, many low-cost electricity sellers are a hit, as are traders who bought energy at the lowest pre-war prices. As these market players rake in billions of euros in profits, consumers’ electricity bills soar. Electricity prices in energy-rich Norway, with its huge oil and gas reserves and hydropower capacity, have risen almost tenfold.

Meanwhile, households and small businesses are being pushed to the brink, and even some large companies have already gone bankrupt. Last month, Uniper UN01,
+7.97%,
a large company supplying a third of Germany’s gas, has been ‘nationalised’, effectively socializing its massive losses. The European principle of “no state aid” was abandoned, mainly because European leaders moved too slowly to change a market structure that was not designed for war.

As the Vietnamese understood, wars are won as much on the political front as on the battlefield.

Economists like marginal cost pricing because it provides appropriate incentives and because its distributional consequences tend to be small and easily manageable in normal times.

But now the incentive effects of the system are weak and its distributive effects are huge. In the short term, consumers and small businesses will need to turn their thermostats down in the winter and turn them up in the summer, but comprehensive energy-saving investments take time to plan and implement.

Non-linear pricing

Fortunately, there is a simpler system (already under discussion in some countries, and already partly implemented in others) which would retain most of the incentive effects of marginal cost pricing without the distributive effects. In a non-linear pricing framework, households and businesses could be allowed to buy 90% of their supply from the previous year at the price of the previous year, and 91-110% of supply at, say, 150 % of the price of the previous year, before the margin – the cost price intervenes.

Although non-linear pricing cannot be used in many markets, due to the possibility of “arbitrage” (buying a good at a low price and reselling it immediately at a much higher price), electricity does not not part of it. This is why some economists (like me) have long advocated its use in cases where large market failures have large distributional effects. It is a powerful tool that governments can and should use, especially when faced with conditions of war.

Something must also be done about soaring food prices. After half a century of paying American farmers not to grow crops (an old method of supporting agricultural prices), we should now be paying them to produce more.

Such changes have become imperative. As the Vietnamese understood, wars are won as much on the political front as on the battlefield. The goal of the 1968 Tet Offensive was not to gain territory but to change the political calculus of war, and it worked.

Sharing the Burden of War

Defeating Russia will obviously require more help for Ukraine. But it will also require a better economic response from the wider West. It starts with sharing more of the burden through windfall taxes, controlling key prices – such as those for electricity and food – and encouraging government interventions if needed to alleviate critical shortages.

Neoliberalism, based on simplistic ideas about how markets should operate who do not understand how they Actually work, didn’t work even in peacetime. This should not prevent us from winning this war.

Joseph E. Stiglitz, Nobel laureate in economics, is a professor at Columbia University and a member of the Independent Commission for the Reform of International Corporate Taxation.

This commentary is courtesy of Project Syndicate — Wars are not won with economies in peacetime

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