The Unwarranted Ukraine Proxy War: A Year Later – Analysis

Dan Steinbock

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To Russia and Ukraine, the crisis is an existential issue. To the US and NATO, it’s a regime-change game. To Europe, it means the demise of stability – in the world economy, lost years (and that’s the benign scenario).

That’s how I characterised the US/NATO-led proxy war against Russia in Ukraine back in early March 2022. I argued that it was an “avoidable war that will penalise severely Ukraine, Russia, the US and the NATO, Europe, developing countries and the global economy”.[1]

At the time, the prediction was seen as contrarian. But it has prevailed. However, on January 25 the Ukraine proxy war entered a new, still more dangerous phase. The commitment of some 70 US, German, UK and Polish battle tanks herald lethal escalation, although hundreds more are needed to defeat Russia. For the first time since World War II, German tanks will be sent to the “Eastern front.” In Moscow, it will foster those voices who see the stakes of the war as existential.

Not only will economic and human costs climb even further, but strategic risks, including the potential of nuclear confrontation, will soar. With such escalation in high-tech arms sales to Ukraine, regional and military spillovers are no longer a matter of principle, but a matter of time.

Russia’s economic resilience

In early 2022, Western observers, with rare exceptions, predicted that the Russian economy would default within months as a net effect of sanctions. “Putin’s war” was doomed, they said. Obviously, the sanctions, which have been fuelled by might and economic coercion, have not been inconsequential. But nor were they new.

Already in February 2014, following the Russian annexation of Crimea, international sanctions were imposed against Russia and Crimea by the US, Canada, the EU, and the international organisations they dominate. While the West’s sanctions contributed to the fall of the Russian ruble, they also caused significant economic damage to the EU economy, with total losses at €100 billion in 2015. By mid-2016, Russia had lost an estimated $170 billion due to financial sanctions and another $400 billion in revenues from oil and gas.[2]

According to the IMF’s country report in April 2022, the Russian economy was projected to see an 8.5 per cent decrease in its real GDP in 2022, with inflation of 21.3 per cent in that same year. Other Western multilateral banks and financial institutions echoed the disastrous forecasts. Nonetheless, despite the gloom and doom projections in the West, Russia has prevailed. “As for the economy, despite the collapse, disarray and catastrophe predicted for us in the economic sphere, nothing of the kind has happened,” President Putin stated before Christmas 2022.[3]

In fact, the Russian economy plunged 3.5 per cent in 2022, whereas inflation amounted to 5.4 per cent. In other words, Western institutions dramatically overestimated the GDP impact. Discrepancies of such magnitude are hard to explain away as simple prediction errors (figure 1).

Figure 1: Western predictions, Russian realities

Russia’s economy contracted significantly less than initially expected in 2022, due to the strong fiscal response and the surge in energy prices which increased fiscal revenues. Nevertheless, it experienced a sharp drop in imports, a fall in real incomes and the recession will continue in 2023.

Proxy war united Russia

Officially, the invasion of Ukraine began as Russia’s “special military operation”. Unofficially, it soon morphed into a US/NATO-led proxy war against Russia in Ukraine. The true political objective of this war has been regime change. Hence the goal “to weaken Russia”, as Secretary of Defence Lloyd Austin acknowledged later. Hence, too, the international media predictions that the Russian economy would “inevitably” default and Putin be overthrown.

By contrast, I projected that the reverse might occur. The economy would suffer, but prove resilient. Putin’s ratings would climb. A perceived existential threat would unite the Russians. The credibility of Washington and Brussels would tank. Though contrarian almost year ago, the predictions proved valid.

Today, in the view of ordinary Russians, Russia’s invasion of Ukraine is a defensive response to NATO’s offensive eastward enlargement. They see their country fighting for survival. That’s why the war caused Putin’s ratings to soar to the low 80s. That’s also why over 60 to 70 per cent of Russians support their government and believe the country is on the right track, despite extraordinary hardships. If the war has achieved anything, it has caused negative sentiments to climb against the US and the EU – from less than 50 per cent up to 70, even 80, per cent (figure 2).

Figure 2: How the proxy war consolidated Russia

Source: Levada Center (Russia), Jan. 2023

Amid this collapse of trust in the US and the EU, it certainly did not help that the Minsk peace process proved to be another Western ruse. Last December, German ex-Chancellor Angela Merkel disclosed in the Zeit newspaper that “the 2014 Minsk agreement was an attempt to give time to Ukraine.” That is, to make Ukraine stronger and for NATO to increase its support to the country in the face of Russia.[4]

From the standpoint of Moscow, such past ‘betrayals” cloud any new potential Ukraine deal in the future. “Nobody planned to live up to these Minsk agreements,” Putin commented. “[The participants] lied to us, and the only reason for these processes was to pump Ukraine up with weapons and get it ready for military action… Maybe this [war] should have been started earlier.”[5]

In the view of ordinary Russians, there is now a long continuum of betrayals from the pledge that NATO would never expand eastward in the early 1990s to Minsk today. In their view, the West’s recent arms escalation only confirms their worst suspicions.

Contradictory realities

Right before Christmas, President Volodymyr Zelenskyy delivered an emotional wartime appeal to a joint meeting of US Congress, pleading for more military assistance from the lawmakers, who were about to approve $45 billion in additional aid. It was necessary for “eventual victory”.[6]

Yet, there was a huge disconnect between the triumphant declaration and the realities. Earlier in the month, European Commission President Ursula von der Leyen had acknowledged that Ukraine’s losses in the war amounted to 100,000 soldiers and 20,000 civilians, though her tweet was quickly deleted and a new one was released without the true death count.[7]

Behind the choreographed photo ops and bold sound bites, devastation had been expansive, progressive, and relentless. In September 2022, a month before the Russian winter offensive, a World Bank report estimated that Russia’s invasion had caused over $97 billion in direct damage to Ukraine and it could cost $350 billion to rebuild the country. Worse, Ukraine had also suffered $252 billion in losses through disruptions to its economic flows and production, as well as extra expenses linked to the war.[8] (The report was quiet about the economic and human costs on the Russian side.)

In other words, what Zelenskyy asked in the Congress was less than one-tenth of what is actually needed to rebuild Ukraine.

Ukrainian nightmare

In effect, even as the international media was touting the mirage of Ukraine’s military triumph, the country’s real GDP declined over 35 per cent on an annual basis in the third quarter of 2022; that is, before Russia’s massive infrastructure attack.

Starting on 10 October, Russia’s waves of missile and drone attacks opened a new phase of the war. The direct physical damage to infrastructure soared to $127 billion already in September; that’s over 60 per cent of Ukraine’s pre-war GDP. The impact on the productive capacity of key sectors, due to damage or occupation, is substantial and long-lasting.[9]

The population share with income below the national poverty line in Ukraine may more than triple, reaching nearly 60 per cent in 2022. Poverty will increase from 5.5 per cent in 2021 to 25 per cent in 2022, with major downside risks if the war and energy security situations worsen.[10] As casualties continue to mount, over a third of the population has been displaced and over half of all Ukrainian children have been forced to leave their homes. The nine months of war have caused massive population displacement. As of October 2022, the number of Ukrainian refugees recorded in Europe was over 7.8 million, and the number of internally displaced people was 6.5 million (figure 3).[11]

Figure 3: Overview of population displacement (12 December 2022)

Source: Ukraine Situation Report, UN-OCHA, Dec. 22, 2022

As former Pentagon adviser Col. (ret.) Douglas Macgregor has argued, “Washington’s refusal to acknowledge Russia’s legitimate security interests in Ukraine and negotiate an end to this war is the path to protracted conflict and human suffering.”[12]

West’s tough 2022 and darker 2023

Currently, the risk of recession casts a dark shadow over the US economy, in which rising food and energy prices, coupled with a tight labour market and the Federal Reserve’s misguided monetary responses, pushed inflation to multi-decade highs in 2022. This was aggravated by the belated and most rapid monetary tightening in more than 40 years, as I projected a year ago.[13]

Overall, US growth for 2022 slowed to 1.9 per cent as substantial fiscal consolidation – worth about 5 per cent of GDP – added to monetary headwinds. Worse, growth is projected to slow to recession level in 2023; that’s over 2 percentage points below previous forecasts, the weakest performance outside official recessions since 1970.[14]

With the proxy war in Ukraine in the second half of the year, activity in the euro area fell significantly, due to soaring energy prices and supply uncertainty, compounded by rising borrowing costs. Meanwhile, inflation rose to record highs as the war led to natural gas supply cuts and surging energy prices. Estimated at 1.2 per cent of GDP in 2022 and up to almost 2 per cent of GDP in 2023, fiscal measures were introduced by European governments to soften the impact of energy price increases. In 2023, growth is forecast to contract, which means a downward revision of over 2 percentage points.

Even the not-so-United Kingdom is struggling with the worst fall in living standards since records began.

In Japan, growth is expected to slow further to 1 per cent in 2023. In its quarterly report, the Bank of Japan (BOJ) said 53 per cent of people surveyed admitted their wealth had slumped last year compared to 2021, the highest percentage of households reporting financial problems in almost 13 years. Worse, the BOJ expects prices will continue to rise and has doubled its inflation forecast for the coming year to a record 10 per cent.[15]

US and international war funding

In the proxy war, economic and humanitarian aid to Ukraine has been abundant. By late fall, Congress had passed three aid packages totalling $68 billion. In turn, the Biden administration submitted a new aid request of $38 billion, which would bring the total to $106 billion. Though designed until September 2023, it is likely to be exhausted by May, assuming the current rate of spending ($6.8 billion per month). By then, the Biden White House must ask for additional funds.[16]

Internationally, the US provides the bulk of total aid to Ukraine (62 per cent). Aid from non-US sources amounts to $41.4 billion. The international total of more than $110 billion accounts for more than half of Ukraine’s pre-war GDP ($200 billion).[17]Effectively, these funding arrangements aim to sustain the hostilities and destruction not just in 2023, but at least until the late 2020s.[18] A scenario the West’s recent arms sales escalation could reinforce.

Ailing and indebted, the West cannot afford the proxy war in Ukraine. Hence, the frantic debt-taking. In the Eurozone, government debt to GDP remains close to 100 per cent. Ironically, that’s 40 percentage points higher than the region’s own debt limit. In the UK, the figure has doubled since 2008 to almost 100 per cent. In Japan, it is the worst among all high-income economies – close to 265 per cent, thanks to over two decades of secular stagnation. In the US, the debt ratio has also doubled and is inching toward 140 per cent. (That’s over 20 percentage points higher than that of Italy amid Rome’s 2010 debt crisis.) The rising debt as a percentage of the GDP will slow economic growth, push up interest payments to foreign holders of US debt, and heighten the risk of a fiscal crisis. The periodic debt-limit debacle in the US is just a minor political sideshow to the West’s future debt crisis, which will leave no economy, not even the major ones, unscathed (figure 4).

Figure 4: The West’s debt spiral

Gross government debt as % of GDP (2012-22) Source: Trading Economics; Difference Group

The post-9/11 wars: the Big Defence bonanza

Ukraine is “absolutely a weapons lab in every sense because none of this equipment has ever actually been used in a war between two industrially developed nations,” said one source familiar with Western intelligence to CNN. “This is real-world battle testing.” Or as Zelenskyy put it more recently, arming Ukraine is a “‘big business opportunity,” as evidenced by his government’s new ties with Blackrock, Goldman Sachs and JP Morgan. In December 2022, he revealed that Ukraine had hired Blackrock to “advice” Kyiv on how to use the West’s reconstruction funds, which he then estimated would have to increase at least to $1 trillion.[19]

As I predicted in March 2022, US Big Defence will be the only winner of the proxy war in Ukraine. Not only do these global military contractors arm Ukraine, but they stand to benefit from the re-militarisation of Western European countries, Japan, and new NATO members. Washington has a great economic interest in such geopolitics. Brussels’ incentives are harder to fathom, especially as the euro area will pay a hefty premium on energy and food, which will also benefit Washington.

For decades, security cooperation programmes have led US forces into unauthorised hostilities alongside foreign partners, particularly Afghanistan, Iraq, maybe Libya in in the past two decades. But the list is off by at least 17 countries in which the US has engaged in armed conflict through ground forces, proxy forces, or air strikes.[20]

The simple reason is money. War may be a racket, but it is a very lucrative racket. In the past two decades alone, the cost of the US global war on terror stands at $8 trillion and 900,000 deaths (the costs in target countries are far, far higher).[21] And this estimate is from fall 2021, more than a year before the Ukraine bonanza.

War profiteering has always been lucrative to military contractors. But the post-9/11 wars represent an entirely different magnitude. During the past two decades, the stock prices of Big Defence have doubled, quadrupled, even soared sixfold (figure 5).

Figure 5: Post-9/11 Wars: The Big Defence Bonanza

Source: Tradingeconomics; DifferenceGroup, 16 Jan 2023

Military Keynesianism to rescue

From the economic standpoint, these military expenditures, including US Ukrainian aid, should be seen as massive, recurrent, multi-year bastard Keynesianism. That is, as a series of military stimulus packages to prop up the American economy (not Ukraine’s). Unlike Keynesian stimuli that can have an accelerator effect in the civilian economy, these packages benefit mainly the Pentagon and Big Defence; that is, the military industrial complex and its revolving-door elites.

Take, for instance, President Biden, Secretary of State Antony Blinken, National Security advisor Jake Sullivan and Blinken’s right-hand, Victoria Nuland. All four were key actors already in the 2014 Ukraine crisis. In one way or another, all are also linked with the Center for a New National Security (CNAS) and its consulting arm WestExec Advisors, which in turn is funded particularly by Big Defence. The same goes for Secretary of Defence Lloyd Austin, a veteran of the US Army and ex-board member of Raytheon, one of the largest defence giants and a big beneficiary of the Ukraine devastation.[22]

But what’s good for Big Defence is not necessarily good for either the American people or the global economy. It aggravates income polarisation in America and between the high-income West and the developing Global South, while escalating geopolitical risks worldwide. This time it’s different, as Douglas Macgregor warns his fellow Americans: “Neither we nor our allies are prepared to fight all-out war with Russia, regionally or globally. The point is, if war breaks out between Russia and the United States, Americans should not be surprised. The Biden administration and its bipartisan supporters in Washington are doing all they possibly can to make it happen.”[23]

Plunging global growth

Unsurprisingly, global growth is now expected to decelerate sharply to 1.7 per cent in 2023. That’s the third-weakest pace of growth in nearly three decades, except only for the global recessions caused by the pandemic and the global financial crisis. The US, the euro area, and Japan are all undergoing a period of pronounced weakness, and the resulting spillovers are exacerbating other headwinds faced by emerging and developing economies.[24]

Once again, the poorest economies are paying the heftiest bill for the ill-advised policies of the high-income West. The long-term scarring effects of the overlapping adverse shocks of the past three years have led to large cumulative losses, especially with respect to output. These losses will be even larger in a sharper global downturn or recession. Moreover, the recovery of global trade following the 2020 global recession is on course to be substantially weaker than the rebounds seen after previous global recessions, including the mid-70s oil crisis that effectively halved growth rates in the West. The West’s secular stagnation and costly geopolitics go hand in hand (figure 6).

Figure 6: The Ukraine war impact

Cumulative Output Losses, 2020-24 (% of 2019 GDP) Source: Global Economic Prospects, World Bank, Jan. 2023

In emerging and developing economies, growth prospects have worsened substantially, with the forecast for 2023 downgraded 0.8 percentage points to a subdued 3.4 per cent. While the West is haunted by energy and food inflation, poorer economies struggle with massive energy disruptions and lethal famines. As Oxfam reports, since 2020, the richest 1 per cent have captured almost two-thirds of all new wealth, nearly twice as much money as the bottom 99 per cent of the world’s population. In particular, food and energy companies more than doubled their profits in 2022, paying out $257 billion to wealthy shareholders, while over 800 million people went to bed hungry.[25]

In 2023, China’s reopening could offset a decline in other emerging and developing economies.[26] That, however, is predicated on continued easing in US-China relations, which is no longer assured. Worse, with historical plunges of world trade, investment and migration, effective de-globalisation has the potential to transform cold wars to hot ones.[27]

The unwarranted war

A year ago, I characterised the Ukraine conflict as an “unwarranted war” because it was avoidable. As declassified files show, a series of security assurances were given to Mikhail Gorbachev and other Soviet leaders against NATO’s eastward expansion at the turn of the 1990s, starting with President George H.W. Bush, followed by a cascade of assurances by German, French, British, and NATO leaders. The betrayal of these pledges was widely condemned already in 1997 by 50 US foreign policy authorities, including the leading Cold War hawks, in an open letter to President Clinton. What has ensued is three decades of NATO eastward expansion, which has made the world poorer and less secure, just as these US experts predicted over 25 years ago.[28]

If in 2022 the proxy war’s costs were disastrous in the West and Russia, 2023 will be worse. One way to quantify these adverse shocks is to compare consensus growth estimates before the Ukraine conflict and today after a year of devastation (figure 7).

Figure 7: The costs of the proxy war in major economies

Data from Global Economic Prospects, World Bank, January 2021 and 2023. Trend growth, based on the 2021 data, has been projected up to 2024 (round dots in red). The difference between the two charts reflects the missed opportunities.

Here are some takeaways:Following the West’s debt crises in the early 2010s, the rise of US protectionism and trade wars since 2017, the consequent failed global recovery, vaccine apartheid amid the global pandemic and the subsequent global depression, the proxy war is costing the global economy trillions of dollars annually.

In 2022-3 alone, the war is contributing to a loss of 1-2 percentage points of US GDP growth per year. In the $25 trillion economy, that means up to $250 to $500 billion.

In the euro area, the losses are likely to be significantly higher. In the $16.6 trillion economy, that’ll turn a promising recovery into an ominous contraction. These aggregate results exclude the UK, in which living standards will suffer longer.

In Japan, the world’s second-largest economy, the pre-Ukraine potential for stabilisation will give way to the kind of instability that triggered its secular stagnation in the 90s, due to the country’s massive debt burden and record high-age structure.

In this dire status quo, the decision of the G7 countries to foster their military capabilities is precisely the wrong one. It will escalate their debt challenges. As they have opted for warfare rather than welfare, their income polarisation will worsen accordingly. Japan is a case in point. Although it has been in secular stagnation over two decades, its sovereign debt is pushing the country toward an abyss and its age structure is alarmingly grey, it has decided to bury its postwar pacifism, which once allowed it to revive its economy, and double its military expenditure, which once resulted in its economic devastation.

Russia is a $2.1 trillion economy and a global supplier of oil and natural gas, plus a major nuclear power. Yet, the war means 5 to 6 percentage points in lost GDP growth. While the maths are distressing, Russians believe that NATO Ukraine would have pushed their country back to a 90s-style nightmare. Moreover, data suggests that, if Russia can prevail, its growth could be restored by the mid-2020s.

To undermine such scenarios, the US and NATO seem to be preparing for a multi-year proxy war, despite its self-destructive impact on the G7 economies, the continued energy and food crises, and the likely devastation in emerging and developing economies.

The year 2022 turned the Ukrainians’ dream of peace and development to ashes, as over a third of their economy disappeared, perhaps a quarter of the population fled and a generation of young men was sacrificed for the West’s geopolitics. What’s ahead in 2023 will be worse. Reconstruction will require a lot more than $1 trillion, according to Zelenskyy. That’s over five times Ukraine’s pre-war GDP.

US Big Defence is the big winner of 2022 and, thanks to the military aid arrangements, could reap war profits well into the late 2020s. By then, new big “weapons labs” will be needed elsewhere – North Korea, Taiwan, Iran, perhaps even China, where there’s a will, there’s a way – to ensure new wars that will generate adequate returns.

As long as Washington is willing to extend its war theatre from Ukraine to other targets, global risks will climb accordingly, including potential nuclear confrontations and the ultimate climate risk: “nuclear winter”.

Following the US trade wars and the global pandemic depression, the Ukraine crisis came at a time when the world economy can least cope with it. Even worse, the new Cold Wars and military responses steer fiscal packages away from welfare and security, where they are most urgently needed, toward military rearmament drives, which only benefit the princelings of Big Defence.

Undermined peace

As historian Geoffrey Roberts has argued, President “Putin went to war to prevent Ukraine from becoming an ever-stronger and threatening NATO bridgehead on Russia’s borders.”[29] In turn, although Ukrainians had voted for peace and development, they were forced into war and devastation. Hence the crisis escalation, and the deliberate neglect of Austrian-style options for neutrality in the region (and elsewhere in Europe).

In the view of Big Defence, peace is just a bad business proposition. There’s no money in it.

The war was not the Ukrainians’ first choice either. On the contrary, initially it was their last choice. When Zelenskyy, whom Ukrainians elected as a “peace candidate”, flirted with the idea of reconciliation with Russia in 2019, Ukraine’s notorious far right, supported by the West, torpedoed it quickly.

Even in April 2022, after a month of hostilities, Russia and Ukraine tentatively agreed to end the war. Yet, that decision was undermined by former British Prime Minister Boris Johnson. His carefully timed Ukraine visit was designed to stop the talks, which were not acceptable to the US and its allies.[30] Today, in Pentagon, Defense Secretary Lloyd Austin sees the escalation as “a window of opportunity here, between now and the spring.”[31]

Only a year ago, Ukraine, under Zelenskyy’s leadership, was still positioned to play a constructive role as a bridge between Eastern and Western Europe, thanks to its vital position in China’s Bridge and Belt Initiative. Had that future prevailed, Ukraine might today be peaceful. Its GDP would be a third bigger. As a neutral country, its trading relationships would have thrived and it would have attracted investment from Russia and both Western and Eastern Europe. Young men would have good jobs. And Ukrainian refugees would be returning for new opportunities at home. When old sectarian conflicts dissipate, escaping abroad is no longer a necessity and even little children sleep their nights rather than being haunted by nightmares, overshadowed by post-traumatic stress.

Today, all those dreams, too, are in ashes. The proxy war is aimed against Russia. The Ukrainians’ role is to die in it. The puppet masters are the primary beneficiaries.