Although there is growing momentum behind a European initiative to embargo Russian energy in response to that country’s war in Ukraine, Germany remains a major obstacle. But, contrary to claims by German political and business leaders, the costs of ending Russian energy imports would most likely be manageable.
MUNICH — Since Russian President Vladimir Putin launched his invasion of Ukraine, the German government has come under increasing pressure to sign on to a proposed European embargo on Russian energy. It is widely believed that stopping Russia’s war will require cutting off its funding, which comes in the form of billions of dollars in payments for oil and gas exports.
German government opposes energy embargo, with Economy Minister Robert Habeck arguing that it would lead to mass unemployment, poverty and widespread social unrest. But are these concerns valid?
Germany is certainly highly dependent on Russian energy. It gets 55% of its gas, 34% of its oil and 26% of its coal from Russia. But finding substitutes for Russian oil and coal would not be particularly difficult.
In fact, Germany has already agreed to join a European embargo on Russian coal, and it has announced its intention to diversify away from Russian oil by the end of this year (although that may be too late to make a difference for Ukraine). Unlike natural gas delivered by pipeline, oil and coal have global markets and can be purchased just about anywhere. Moreover, Germany has strategic reserves of both.
Gas poses a greater challenge, as it can only be delivered through existing pipelines. The question is therefore whether Germany can find short-term substitutes for imports from Russia. For an answer, we can consult a new ECONtribute Policy Note by a group of prominent German economists who sought to quantify the consequences of the end of Russian gas imports. The authors’ results are highly credible. They use a state-of-the-art macro multi-sector model to account for the complexity of modern supply chains and provide detailed knowledge of the German energy market.
The study concludes that an immediate shutdown of Russian gas would cost Germany 0.5 to 2.2% of GDP. This is a potentially significant reduction in growth, but it is by no means catastrophic. Even in the worst-case scenario, the contraction would be less severe than the fallout from the COVID-19 pandemic in 2020, when German GDP fell by 4.6%.
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The estimated production loss varies widely, depending on the ability of the German economy to reallocate resources to other sectors and find gas substitutes. The study assumes that the “elasticity of substitution” is very low, but not zero, meaning that if Russian gas is difficult to substitute, German households and businesses could still switch to other energy inputs and import more gas from the Netherlands or Norway in the short term.
Production losses would be modest (less than 1% of GDP) even if the elasticity of substitution is very low, because in an economy with complex supply chains, there are more possibilities to find alternative suppliers. One risk to consider, however, is what economists call the O-ring function of supply chains (a reference to the catastrophic failure that caused the 1986 Challenger space shuttle disaster): if a crucial link in the chain breaks, all the links below can also collapse, generating fallout that ripples throughout the economy.
Either way, German Chancellor Olaf Scholz dismissed the newspaper in a widely attended speech. interview, arguing that his models do not take into account the realities on the ground. He argues that basic physics — like the time it takes to build a new pipeline — stands in the way of mitigating production losses as much as the paper envisions. Moreover, he insists that the government knows the relevant constraints better than the authors of the study, because it is in constant contact with large companies such as Siemens Energy and chemical giant BASF. Both argue that a Russian gas shutdown would be ruinous.
But during great upheavals, when things break, you have to listen to economists ahead of industry leaders who naturally prefer business as usual. Businesses may know their own day-to-day operations better than anyone, but economists can incorporate deeper historical experience into their models, leaving them better equipped to analyze all the ways an economy might adapt.
The ECONtribute document, for example, incorporates the experience of the 1973 oil shock into its modeling of a potential cut in Russian gas imports. Moreover, Scholz is wrong about the macro models: they respect physicstaking into account resource limitations and other economic constraints.
Ultimately, Germany’s reluctance to follow through on an energy embargo is more than a matter of logistics. The country’s longstanding business model Wandel durch Handel (“change through trade”) will also need to change. Today, the task is not just to manage the effects of lost trade, higher energy prices or weaker growth. It’s about navigating what Scholz sees as a historic turning point – a “Zeitenwende.And, as its response to the ECONtribute document makes clear, Germany is not there yet.