War Economics – A Primer (2025)

Wars are costly, economically and financially, particularly protracted wars that require a significant mobilization of economic resources and last for a long time. A resource- and manpower-intensive war like the war in Ukraine has important economic and financial as well as strategic consequences.

Financing the War Effort

In terms of government finances, increased expenditure on personnel and materiel as well as operations can be sustained through higher taxes, lower non-defense spending, greater debt financing or the drawdown of government’s financial resources. Governments can also finance increased expenditure through direct central bank financing of the budget, which often leads to higher inflation (so-called inflation tax). Russia has thus far financed its war effort by taking on little additional debt (if the official statistics are to be believed), instead relying on the drawdown of financial resources. It is noteworthy, however, that higher inflation has also been instrumental in maintaining a low debt-to-GDP ratio.

To the extent that the war effort relies on foreign resources, the economy needs to be able to acquire imports. Similarly to the domestic, budgetary financing of the war effort, the government (or country) can draw down its existing foreign assets, export goods and services to generate revenue to finance imports or raise foreign debt to do so.

This is where sanctions enter the equation. The freezing of the Central Bank of Russia’s foreign-exchange reserves means that these resources are not available to finance imports. Financial sanctions prevent the Russian government from raising foreign debt. Foreign trade sanctions aim to limit Russia’s ability to generate foreign-currency revenue. Relatedly, export controls are meant to force Russia to deny Russia access to critical imports or at least force it to acquire them elsewhere at higher prices, if available elsewhere. More broadly, trade restriction also imposes what economists call deadweight losses on the economy, leading to overall welfare losses, as the economy is forced to switch to more expensive goods internationally or more expensive sources domestically. Finally, to the extent that its ability to acquire critical technology, whether due to export controls or limited financial resources, it will also weigh on long-term economic outlook in terms of productivity growth.

Economic and Political-Economic Constraints on War Effort

The war effort and sanctions have had and will have a negative impact on the Russian economy in the short and long term. Economically, governments are almost always capable of mobilizing enormous resources to support a war effort. Politically, however, they may be or feel constrained, as the greater the resource mobilization, the greater the relative reduction in household consumption, and the worse the long-term economic outlook.

In the short term, it is possible for increased defense spending to boost economic growth provided the economy is operating at below capacity. It does so by pulling idle resources into economic production, both labor and unused capital. But a very significant increase in defense spending reduces output available for household consumption or decreases domestic savings required to finance domestic investment. Reduced household consumption may weaken domestic support for the war. Reduced investment will weaken the medium- and long-term economic outlook. Importantly, unless an economy is able to pull in additional foreign resources, increased defense expenditure typically has both an economic and political costs, or both. (This is the reverse of the post-Cold War peace dividend when a significant decline in defense expenditure translated into increased savings and investment as well as consumption.)

In addition to the impact of higher defense expenditure on consumption and investment, land wars also remove non-negligible amounts of labour from the economy, particularly in the face of significant battlefield losses. If the potential decline of active labor force is not offset by increasing the labor participation ratio (e.g. women, pensioners), the more limited availability of labor will weigh on the economic outlook. While more limited savings lead to a more limited availability of capital (after depreciation), a more limited labor pool will limit the availability of workers. Both will weigh on long-term economic growth, including the availability to support the war effort by way of a growing economy and available resources.

In short, significant non-defense tends to squeeze investment or consumption, or both. The former weakens the economic ability to prosecute the war. The former and the latter will weigh on private consumption, which may weaken political support for the war. The USSR in part lost the Cold War because it was not able to balance defense-related spending with sustainable long-term economic growth and the political need to sustain sufficient private consumption, thus undermining the government/ regime legitimacy. The Russian leadership is acutely aware of the contribution made by economic and financial difficulties to the fall of USSR.

The Long-Term Economic Consequences of the Ukraine War

If financial data are taken at face value, the Russian government faces manageable near-term economic and financial constraints., are very manageable, economically and financially. Defense spending is estimated a 6-7% of GDP. This may not be sustainable over the medium to long term. But financially speaking, it will not present a problem given lower debt levels. However, high inflation does suggest that domestic demand is running too high. This may require a reduction in domestic consumption to offset increased defense expenditure. This may be politically less palatable for the Russian government in domestic political terms. To the extent that wages do not match inflation, real consumption is already declining, of course, pointing to the trade-offs discussed above.

None of this means that Russian cannot mobilize further resources for the war effort, such as reducing household consumption or increasing the labor participation ratio. But it does indicate that increased defense spending and personnel losses do have a material cost to Russia’s short-, medium- and long-term economic prospects. And this is before factoring in the welfare and productivity losses due to reduced international trade and more limited or more costly access to advanced foreign technology. 

In the decade leading up to 2022, the Russian real GDP growth averaged 1.4%. If sanctions and trade restrictions remain in place and Russian maintain defense expenditure of more than 6% of GDP, the economy is at risk of entering stagnation over the medium term. More optimistically, the IMF is more optimistic, projecting real GDP growth of 1.1% in 2026-30. However, given a shrinking workforce, aging technology, stagnating to declining domestic investment, the Russian economy will fare far worsen over the next decade than over the past decade. This, in turn, does create domestic and strategic constraints for the Russian government, not least because its ability to significantly increase defense expenditure will be constrained politically and, at least in the longer term, economically.

Economically, a government can almost always extract additional resources to support a war effort, at least in the short term, by reducing private consumption or domestic investment. However, a sharp reduction of private consumption may prove politically difficult. A sharp reduction in investment will curtail the long-term sustainability of high defense expenditure. The latter would also weaken Russia, whose relative economic position is already relatively disadvantageous in terms of the size of its economic base. In terms of GDP, Russian defense expenditure is already more than three times the expenditure in European NATO countries, while the combined economic size of European NATO, let alone al NATO members is far greater than Russia’s. On a nominal GDP basis, Russia’s economy is about 1/15 of America’s or about the size of Canada. On a purchasing power parity basis, Russia is 20% of European NATO members’ GDP. In other words, Russia is already in an economically disadvantageous position and continued high defense expenditure will lead to a further relative weakening of Russia’s economic power. 

The EU Should Change Its Approach to Countering Trump’s Tariffs (2025)

See also: https://ip-quarterly.com/en/eu-should-change-its-approach-countering-trumps-tariffs

The US president’s powers to set trade policy are vast and unlikely to be checked. Therefore, Brussels should try to influence Trump’s cost-benefit calculus rather than targeting other actors.

The United States’ trade policy has taken a dramatic protectionist turn, increasing the risk of a broader transatlantic trade conflict. If current EU-US trade negotiations over the removal of “reciprocal” tariffs fail, the European Union will adopt retaliatory measures targeting US imports. (US President Donald Trump imposed these tariffs on April 2, but then suspended them for 90 days, before threatening the EU with 50 percent tariffs by June 1, again deferred after a telephone call with European Commission President Ursula von der Leyen last weekend.) 

But even if a transatlantic trade conflict can be averted, the EU needs to review its trade defense and deterrence policies. Instead of simply adopting proportionate retaliatory tariffs, Brussels should consider devising a policy that more directly and immediately affect the cost-benefit calculus of the institutionally dominant American trade policymaker: the president.

Wide-Ranging Powers

The Trump administration’s policies have been made possible by the president’s extensive trade authority. Article I, Section 8 of the US Constitution confers the power to collect taxes and duties and to regulate commerce to Congress. However, starting in the 1930s, Congress began to delegate some of its trade-related prerogatives to the executive. 

Several laws give the US president wide-ranging, if not unlimited, powers to impose trade restrictions. Under Section 201 of the 1974 Trade Act, the president can impose trade restrictions if imports are found to cause serious injury. Under Section 301 of the same act, the president can also impose restrictions in case a foreign government is found to be violating an existing trade agreement or discriminates against US companies. And under Section 232 of the 1962 Trade Expansion Act, the president can impose trade restrictions on national security grounds. Finally, and crucially, the International Economic Emergency Act (IEEPA), enacted in 1977, allows the president to impose wide-ranging economic restrictions on another country following a presidential declaration of a national emergency. 

Other, if partially older, trade legislation exists but, unlike Section 201, 301, and 232, trade-restricting measures under these laws have never been imposed. Nonetheless, the acts indicate how extensive the US president’s trade authority is. 

Section 338 of the Tariff Act of 1930, for example, authorizes the president to impose 50 percent tariffs in case US commerce is found to be discriminated against by another country. Section 122 of the 1974 Trade Act allows the president to impose 15 percent tariffs on the imports of another country of up to 150 days in the event of persistent and large balance-of-payments imbalances. Section 891 of the Internal Revenue Code of 1934 allows the president to double domestic taxes on companies and individuals from countries that have been found to be discriminating against US companies in terms of their domestic taxation regimes.

Significant Flexibility

The trade instruments available to the president differ in terms of the extent, target, and the duration that trade-restricting measures can be imposed. IPEEA gives the president maximum flexibility without having to undergo time-consuming investigations or face restrictions in terms of proportionality, duration, or sector-specific restrictions. The president can simply declare a national emergency and take a wide array of measures aimed at restricting cross-border exchange. (Or at least this is how extensively the Trump administration has interpreted the law.) 

By comparison, Sections 201, 232, and 301 tariffs typically require time-consuming prior investigations before trade-restricting measures can be imposed. Moreover, Section 201 only provides for time-bound, product-specific or sectoral safeguards. Measures taken under Section 232 are not time-limited, but they typically affect specific sectors, while measures under Section 301 require separate investigations and determination on an individual country basis. However, where individual instruments do limit policy flexibility, the president can simply activate, though more cumbersome, different instruments to maximize trade-related leverage vis-à-vis other countries.

Both the US Congress and the courts can, in principle, act to restrict or restrain presidential trade authority. Congress has delegated significant trade-related powers to the president but can reclaim the authority it has delegated. It can also restrict the president’s ability to impose trade-related measures under IPEEA by declaring an end to a national emergency through a joint resolution adopted by both the House of Representatives and the Senate. 

However, if the president vetoes the resolution, a two-thirds majority in both chambers is required to overrule the veto. Under current political conditions characterized by a high degree of partisanship and polarization, Congress is highly unlikely to restrict the president’s trade-related authority. Reclaiming delegated trade authority faces similar, high hurdles. Courts, too, might be able to constrain the Trump administration by rejecting its extensive interpretation of its statutory authority in trade matters. But courts have historically shown deference to the executive on questions of international trade, national security, and national emergencies. 

US Trade Policymaking

For all these reasons, it’s safe to predict that Trump’s trade authority will remain extensive and his ability to set policies will remain largely unconstrained. A high degree of policy flexibility allows the president to use tariffs as an all-purpose instrument to opportunistically gain economic leverage in pursuit of varying economic and geopolitical goals. 

A trade policy characterized by what may be called a transactionally-focused, coercive protectionism accounts for the capricious nature of policies. US trade policy is not informed by intellectually coherent strategy guided by a more predictable inter-agency process. All this is made possible by the president’s substantial authority to impose trade restrictions.

Relatedly, the administration has been as quick to announce and impose protectionist measures as it has been to retract them, often in the context of increasing economic and financial costs risks stemming from these measures.

The President’s Cost-Benefit Calculus

This fact should inform a rethink of EU trade policy vis-à-vis the United States. Instead of simply opting for proportionate trade retaliation—holding trade proportionate retaliation in reserve to facilitate successful negotiations—the EU should at least consider ways to strengthen the political effectiveness of its trade defense and deterrence policies by more directly taking into account the president’s cost-benefit calculus. 

No doubt, such an approach is risky because it can quickly lead to escalation, as the recent US-China tariff tit-for-tat has shown—and in this case China only retaliated proportionately. It also requires a solid understanding of what the president’s cost-benefit calculus is. But it makes more sense to want to shift the president’s calculus more directly rather than take measures that seek to target other US political actors with little or no influence over the trade policy process. In this context, the EU should also consider pre-emptively activating its newly created anti-coercion instrument to provide it with greater policy flexibility.

Seeking to influence other senior officials at the State Department, the Commerce Department, the Treasury, or the Office of the United States Trade Representative, for example, will only have a limited effect. Senior officials have already made up their mind as to the desirability of policies and are simply waiting for the politically opportune moment to move policy in their preferred direction. Appeals to or policies seeking to mobilize Congress against protectionist trade policies would be similarly ineffective. Things would have to become a lot worse economically for Republican members of Congress to gang up with Democrats to subvert the president’s trade policies. 

Traditional trade retaliation that disproportionately targets the electoral base of the president and his party would not be very effective, either. EU trade retaliation that is supposed to hit Republican-dominated states would not represent much of a threat to Republicans’ electoral base. Retaliation that targets swing states could increase the willingness of electorally vulnerable Republican members of Congress to speak out against the president’s protectionist trade policies. But would be highly unlikely to mobilize sufficient Republicans, as there are too few competitive states and districts to have much of an effect on US trade policy—not least because Republican members of Congress are afraid of antagonizing the president and being subsequently “primaried” in non-competitive electoral districts. 

As long as the president dominates the trade policy process, the EU should consider devising trade defense and deterrent policies that affect the president’s cost-benefit calculus more directly. Judging by the recent twists and turns of trade policy, the president appears responsive to the risk of broader financial market instability, as evidenced by his decision to suspend the reciprocal tariffs following a major bout of treasury market volatility. And even though the president was initially willing to massively escalate measures targeting China, the significant equity market selloff that ensued led to an equally rapid reduction in bilateral tariffs to levels seen as less damaging to the economic outlook. 

Forceful rhetoric notwithstanding, the president’s “revealed preferences” suggest that his trade policy is responsive in the face of increasing economic costs and heightened financial risks. The EU should consider adopting a strategy that credibly and effectively threatens to retaliate and escalate in response to unfriendly, protectionist measures while accepting the risk of broader instability. As the economist and nuclear theorist Thomas Schelling pointed out, such retaliatory threats should leave something to chance, including the risk of a potentially, difficult-to-control escalation, as the risk of such an escalation would not be in the president’s interest.It is obvious that such an approach would be risky because it could prove escalatory. That any such policy needs be evaluated very carefully is clear. But Trump’s trade policy has proven responsive in the face of broader economic costs and financial instability. With extensive trade policy authority vested in the president, the risk of a volatile and unpredictable US trade policy will remain high. Putting in place an effective and credible trade defense and deterrence policy would be highly desirable if European interests are to be safeguarded and transatlantic trade relations stabilized.