The Ukrainian crisis: the Finland option.

The western  boycott on Russia for its invasion of the Ukraine is a modest measure of limited consequence. The only outcome that we should wish for is a “Finlandization” of the Ukraine.

Russia, of course, is vulnerable. That goes particularly for President Putin’s ego. Absence from the G8 meetings would not be prominent on his wish list. But there are compensations: Russian public opinion is as near as unanimous in the military occupation of the Crimea, which Khrushchev bestowed on the Ukraine in 1954, and that all patriotic Russians consider is theirs.

Nor will a collapse of the rouble by 20% or more on world markets dint Putin’s reputation at home. The Russian government has inherited from its predecessors its conviction that high finance, centred in London and New York, is always on the prowl for victims.  At most, the view is that Russia’s oligarchs and banks should exploit their services to promote their, and Russian interests. After all, collective thinking in the Kremlin runs, bankers are greedy.

A western boycott in any case is likely to have limited impact. Germany accounts for one third of EU exports to Russia; Siberia sources 40% of Germany’s gas supplies; and the EU provides 80% of Russian foreign exchange. Visibly, none of the 28 member states are eager to confront Russia, given their own numerous problems at home. China, not Russia, is the prime concern of US business.

There should be no surprise that the EU Council of Foreign Ministers grasps for a boycott. All EU member states are energy dependent, and give overwhelming priority to welfare, while paring back on warfare capabilities. The EU may be the world’s giant emporium, but that is it. On the world stage, the EU is a dwarf, with a loud megaphone, declaring to an empty theatre that the world should follow its example, embrace post modernism and champion human rights around the world, in such countries as Russia, China or Saudi Arabia.

With the fall of the wall in Berlin in late 1989, the EU’s  enthusiasts rejoiced that their moment had come. There was a frisson of worry that a globalized economy would sweep away the constraints on nationalism and trade. But little time was lost in worry: almost immediately, the EU marched boldly into its utopia of a single currency, climate change, a global human rights agenda and an EU constitution of sorts.

It also followed NATO in enlarging its membership from 12 in 1990 to 28 now.  While Russian leaders were pleading for a pan European construct into which they could be included on a footing of equality, NATO in 1996 extended its reach in to Russia’s near abroad. In no time at all, Moscow began to open feelers to Beijing, ending in the historic agreement of 2004, whereby Russia and China agreed on their existing frontier, while China abandoned its claim from the 1860s to reclaim Siberia as theirs.

China’s aim for settling the frontier issue with Russia was grounded in simple realpolitik. Russia was a nuclear power, a UN Security Council permanent member, a major potential source of oil and gas supplies, and in need of friends on the world stage.  China had much more to gain by developing its coastal ports and entering world markets in force rather than quibbling about territory, however extensive.

There was much less interest in Beijing in settling China’s frontiers with India. In 1998, the first thing the newly elected BJP was to demonstrate that India had a nuclear capability, and was therefore on a footing to negotiate with China. But China has been less forthcoming: the two giants rival for influence along the whole area running from Burma, across the Himalayas, and to Pakistan, with which China has been closely allied since the 1970s.

The forces driving globalization meanwhile continued to operate. By the early 2000s, with China’s entry to the WTO, it soon became evident that the world economy was no more the western powers’ oyster. Global trade talks, fostered by the US and the EU, broke down on western farm protectionism, and developed country opposition. The most notable phenomenon was the surge in China’s salience as the world’s prime manufacturing location, source of savings, and record trade surpluses. Chinese savings flowed into the US T bond market, holding down US interest rates even lower than Alan Greenspan,  the then Fed President, intended. With the US Congress rooting for more equal access to housing, the mortgage-lending boom took off to the bust of 2008.

A similar sequence of events occurred in western Europe. Gordon Brown followed in Greenspan’s footsteps, thereby setting the UK up for the mother of all crashes.  More importantly, Chancellor Gerhard Schroeder pushed through his package of reforms designed to ensure that Standort Deutschland (the German manufacturing platform), with wage levels thirty times those of mainland China, remained competitive in the world economy. Wage rates were constrained, productivity and domestic savings soared; and Germany moved to a massive trade surplus with western Europe-as if Germany was playing China to western Europe’s US.

France  and “Brussels” meanwhile carried on as if nothing had changed. While the German government raised retirement age to 67, in order to fund pensions for an ageing population, the French objected to its being raised to 62, and since have dropped the age back to 60. In Brussels, the flags were trotted out to celebrate the great success of the Euro-the EU’s flagship policy, while an EU constitution was pushed through, despite negative votes in referenda in France, the Netherlands and Ireland.

When the bubble burst, it was only a matter of time before the new structure of post cold war Europe came into view. At its centre stood united Germany, Europe’s prime power, and with no equal on the continent.  The Chinese government understood immediately what was happening, and marked the post-1945 coming of age of the Federal Republic by holding a joint Council of Ministers meeting in Berlin.  When France, led by President Sarkozy, proposed not so subtly that Germany, and its smaller northern European partners, underwrite with the rest of Euroland the deficits of France and southern Europe, Chancellor Merkel delivered a polite, but resounding Nein.

Behind all the manoeuvrings around the role of the ECB and the creation of mini bail out funds ran a German morality play that the idle Latins had enjoyed the good times without taking the necessary steps to remain competitive on world markets. Now Berlin, in the goodness of its heart and with a view to Europe’s longer term interests, was taking away the punchbowl.  Southern Europeans should not just renounce debt, but they should abjure sin (Schuld is the word for both in German). For France, the message, though wrapped in velvet, was even more straight: Germany was no longer ready to pay indefinite reparations for World War II, as the EU’s No 1 Europayer.

Why this apparent sudden change in the tone of German diplomacy in Europe?  One reason no doubt lies in the fact that two decades after reunification, Germany, at peace with its neighbours to the west and to the east, no longer felt so enamoured with the idea of sacrificing hard won unity on the altar of a distant EU federal project.  This was most evident in the Constitutional Court’s judgement on the Lisbon Treaty, in which the EU was defined as no more than an alliance of states, and its Brussels based bureaucracy little more than an upbeat international agency. The verdict, and Germany’s behaviour on the European scene, indicated for those who wanted to see that Germany had now taken over de Gaulle’s mantle as a champion of a Europe of the states.

Of course, Germany not being France, there were one or two small differences.  Whereas de Gaulle had pushed for German funds to lubricate French agriculture, in the 2000s, Germany championed the EU’s “internal” market, while refusing to open up its own non-competitive services market.  Over two thirds of total German exports flowed to Europe, while Greek participation in the Euro was welcome to the extent that Athens logistical failings added to those of France and other Mediterranean countries, helped to keep the Euro down, and German world exports up.

Because what was changing rapidly was not Europe’s sluggish economy, so much as the world’s. By 2015, China is expected to absorb 15% of total German exports, compared to France’s 9% and falling. In fact, the UK has already replaced France as Germany’s prime trade partner in Europe. That figure for German exports does not include the sales of goods manufactured in German owned plants in China, which would bring total German sales in China to around 25 to 30% of total German corporate sales. Add the emerging markets of India, Brazil and Russia, as well as all those of the post-Brics- and there can be little doubt where German business longer term interests lie.  They do not lie in a stagnant and welfare dependent Europe.

The forces at work in globalization have levered Germany as it were out of Europe, and made it an imperative for domestic cohesion that Germany remain a manufacturing platform for the world.  But that does not mean the end of geography for Germany. Over the last two decades, German business has assiduously worked through the nitpicking legislation of the welfare state to extract every ounce of competitiveness from its workforce.

The trend has also been to disinvest from non competitive southern Europe, where German business had gone to in the 1970s and 1980s, and to redeploy into central eastern and southern Europe. The EU’s eastern enlargement has greatly helped in terms of setting more uniform standards, and on encouraging states transitioning out of their communist pasts to benchmark on the EU and Brussels.

Germany’s post 1990 Ostpolitik, though, is not just restricted to business. There has always been a very important political dimension. Since 1990, Germany has championed EU enlargement, despite French concerns that the EU is in danger of having its anchor dragged eastwards, because-given what happened in Europe’s blood lands between 1939 and 1945-German diplomacy feels much more at ease in dealing with its smaller or poorer neighbours, in multilateral fora, such as the OSCE, NATO, the Council of Europe or the EU.

Arguably, the most sensitive of all Germany’s eastern relations has been with Poland. Efforts at repairing relations go back a long time, and may for all practical purposes be dated to the 1966 joint statement by the Catholic bishops of Poland and Germany, not for amnesia, but for reconciliation, despite and because of the millions of deaths mourned in Poland, as in Germany. Reluctantly, Germany accepted the post 1945 German-Polish boundaries. But since then, with Polish entry to the EU, a more confident Warsaw, and an evidently democratic and impressive state and people in Germany, Poland under successive governments has become a prime partner of  Europe’s leading power.

There are though one or two caveats to add to this encomium to the European peace process. It is noticeable that just as Germany has become a champion sui generis, of a Europe of the states, so Poland has become a leading champion of the federalist camp in the EU, and its leadership is favourably inclined to joining the Euro-though with the ongoing difficulties of the single currency this may not be considered an urgency.

The other caveat is that Poland is the neighbour of Ukraine and has extremely sensitive relations with Russia.  Like Germany, Poland would like a more stable eastern neighbour, one that necessarily would make it through to being a constitutional democracy. That looked like a possibility  at the time of the Orange revolution in late 2004 and early 2005, when massive demonstrations were staged against the all-pervasive corruption that had marred the recent presidential elections. But little changed in Kiev, while Putin’s Moscow notoriously has used its leverage over the Ukraine as its prime source of energy to keep Kiev on a pro Moscow path.

This tug of war between Ukraine’s western and eastern orientation culminated in the proposal last autumn for Ukraine to enter into a closer arrangement with the EU. Its proponents in Kiev, Warsaw, Berlin and Vienna saw this as proving an incentive for the necessary reforms to be pushed through in Kiev. But Putin interposed his veto.

The key point about the crisis in the Ukraine, and Russia’s occupation of the Crimea, following the referendum yielding a near 100% endorsement of the region’s absorption into Russia, is that the EU’s, and therefore Germany and Poland’s borders with Russia, are not stabilised, as in the case of the China Russian frontier.

A constant of Russian foreign policy since the early 1990s has been  to form a ghost USSR in the form of its “near abroad”. The main vehicles of this policy have been the energy and pipeline companies, closely tied into the Kremlin power grid. They remain active across the lengthen and bread of the old USSR. The other instrument of policy has been the Russian armed forces, which bombed its way to a sort of peace in the two Chechnya wars, and has now stepped in to the breech in the Crimea.

As long as the parameters of Ukraine’s foreign relations are not stabilized, there can be no satisfactory political settlement in Kiev. It is a well known fact that the western, traditionally Catholic Ukrainian population tilts westwards, attracted by the pull of the EU, while eastern Ukraine’s population is traditionally more Orthodox and more amenable to Moscow’s wishes. Crimea is a further complicating factor since it is regarded by Russia’s citizenry as an inalienable part of Mother Russia, while part of Crimea’s population is viscerally opposed to a Russian presence there.

The EU’s political leaders, encouraged by Washington, seem intent on preferring gesture politics to statesmanship. Boycotting Russian oligarchs or not allowing Putin to massage his ego at a G8 summits plays nicely to the media back home, which seem to have drunk  so long at the well of utopian politics that their denizens no longer are of this world. Of course, Russia has infringed national sovereignty, human rights, the code of diplomatic behaviour, and has conducted itself as the local thug on the block. The EU is like a dervish, whirling a terrifying sword, on Putin as Indiana jones armed with a revolver:https://www.youtube.com/watch?v=7YyBtMxZgQs

But that does not excuse western leaders from raising their game away from theatre, however visually impressive, to taking real actions, helpful to Russia, to the Ukraine, to Poland, to Germany and to Austria. It is worth remembering how much is at stake here for the EU. Its flagship Euro policy is holed below the waterline; its climate change policies are being overtaken by the shale oil revolution; human rights diplomacy plays to the home media, but few listen around the globe; the introduction of the EU’s “constitution” has been followed by disintegration, rather than integration. If the EU proposes unconvincing sanctions its appeal to its populations will haemorrhage further.

What is more, it must be remembered  that Russia is a nuclear power, and patriotism the only way to substitute for the poison of Marxist Leninism, which its long suffering populations have endured but also imbibed since 1917.  Its leadership and political system do not walk in western ways. Germany, by contrast, is Europe’s prime power up to the boundaries of Russia, is democratic and peacefully loving.

The two have to make a deal in the wider Europe’s interest. Germany will doubtless do this through multilateral diplomacy in the EU, NATO or the Council of Europe and other fora. Putin, by contrast, may be expected to beat his own breast, sing patriotic songs, speak western when he has to, and wield  big sticks in the form of his armed forces and his energy corporations. For this, we will likely receive wide, but not uniform acclaim back home.

In doing so, a strong component of realpolitik will have to infuse western thinking. What do we want? The answer is simple. We want the European peace to endure, but not at any price. We would like to see Ukraine first stabilized; then, given the change, to prosper; and also to explore its way through the multiple compromises that democratization will inevitably entail to enjoy eventually ever better governance, which we all know is the key to prosperity and to a just freedom.

Despite the real differences in style and substance, a satisfactory peace deal is available. The conditions are there: Russia is a nuclear armed petro-state, vulnerable to a fall; in world energy prices, with a shrieking population, and too dependent on the scarcely inhabited regions of Siberia. The EU prides itself on its soft power, but there are strict limits to what this can achieve.

To get to a peace, we in western countries will have to swallow some of our delusions. We will have to bend our ideals, not stick to them rigidly. We will have to learn that we cannot make the world, yet alone the European near abroad, in our image. We have to make a peace settlement that fits into the contradictory and complex reality of Europe’s mosaic of states and peoples.

That means Finlandization of the Ukraine. In the late 1940s, the western allies, primarily the US and the UK, and the USSR, came to an agreement to keep Finland out of the cold war, which was gathering in intensity at the time. Rather than absorb Finland back into the bosom of Mother Russia, or to convert it into a client, communist state as in Poland, and elsewhere in central and south eastern Europe,  Stalin agreed to accept Finland’s neutrality status.

It lasted for forty years. The rules of the game were clear: Finland could neither tilt to the Soviet Union nor to the western powers. Internally, politics and language had to be neutered to hold the fort. Within those constraints, the Finns set about constructing what has become one of the world’s exemplars of a well functioning market democracy.

Such a policy does not mean that the EU should appease Moscow. Sanctions and boycotts have their modest role, as does EU underwriting of a strengthened association with the Ukraine. But the EU has to realize that speaking firmly to Putin requires that its member carry a collective big stick of European warfare capabilities, along with active development of a more coherent energy policy that reduces massive overdependence of Germany and its eastern European neighbours on Russian sources.

This will take time. Consequently, the EU response to Putin’s unilateral occupation of the Crimea has to be calibrated in terms of what can be achieved; of what cannot be achieved; of what we do not want to achieve;  and what may or may not be achievable.

What can be achieved is that the EU collectively back the new government in Kiev. What is probably not achievable is to dislodge Putin from the Crimea, where he has placed Russian boots on the ground in clear contravention of international best practice; what we do not want to achieve is to push Russia into ever closer relations with China; what may or may not be achievable is to stabilise domestic Ukrainian politics.

Failure to rise to the opportunity of entrenching a European peace will not just further hammer a nail into the EU’s coffin: the undertakers hammers are already audible.  It may avoid a prolongation of Ukraine’s political no man’s land, or worse its descent into civil war, with one half of the Ukraine backed by a bombastic and nuclear powered state, and the other supported by Brussels.

The stakes may scarcely be exaggerated: we have a chance to cement the European peace. The model should not be the Stalin-Hitler Pact of August 1939, which effectively divided what became the blood lands of Europe as the clash of titans unfurled. The model should be Finland of 1948. We must not strive for perfection, but for the realizable. In order to negotiate with Moscow, he have to prepare for the worst. This is not the time for prevarication, the EU’s favourite mode.

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About Jonathan Story, Professor Emeritus, INSEAD

Jonathan Story is Emeritus Professor of International Political Economy at INSEAD. Prior to joining INSEAD in 1974, he worked in Brussels and Washington, where he obtained his PhD from Johns Hopkins School of Advanced International Studies. He has held the Marusi Chair of Global Business at Rensselaer Polytechnic Institute, and is currently Distinguished Visiting Professor at the Graduate Schoold of Business, Fordham University, New York. He is preparing a monograph on China’s impact on the world political economy, and another on a proposal for a contextual approach to business studies. He has a chapter forthcoming on the Euro crisis. His latest book is China UnCovered: What you need to know to do business in China, (FT/ Pearson’s, 2010) (www.chinauncovered.net) His previous books include “China: The Race to Market” (FT/Pearsons, 2003), The Frontiers of Fortune, (Pitman’s, 1999); and The Political Economy of Financial Integration in Europe : The Battle of the Systems,(MIT Press, 1998) on monetary union and financial markets in the EU, and co-authored with Ingo Walter of NYU. His books have been translated into French, Italian, German, Spanish, Chinese, Korean and Arabic. He is also a co-author in the Oxford Handbook on Business and Government(2010), and has contributed numerous chapters in books and articles in professional journals. He is a regular contributor to newspapers, and has been four times winner of the European Case Clearing House “Best Case of the Year” award. His latest cases detail hotel investments in Egypt and Argentina, as well as a women’s garment manufacturer in Sri Lanka and a Chinese auto parts producer. He teaches courses on international business and the global political economy. At the INSEAD campus, in Fontainebleau and Singapore, he has taught European and world politics, markets, and business in the MBA, and PhD programs. He has taught on INSEAD’s flagship Advanced Management Programme for the last three decades, as well as on other Executive Development and Company Specific courses. Jonathan Story works with governments, international organisations and multinational corporations. He is married with four children, and, now, thirteen grandchildren. Besides English, he is fluent in French, German, Spanish, Italian, reads Portuguese and is learning Russian. He has a bass voice, and gives concerts, including Afro-American spirituals, Russian folk, classical opera and oratorio.
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