At WEF you said that people in Russia face “incredible poverty” because of the Western sanctions. But we don’t see anything like that so far. The economic crisis turned out to be much less painful than expected, at least for now. Why do you think that is the case?

Well, it’s a long term proposition — becoming more and more isolated from the world and having more sanctions, fewer countries to trade with. The other countries which have faced very strong sanctions, of course, are very poor. That’s not the case for Russia in the near term. It would take 50 years for Russia to get to look like Cuba. Countries are still trading [with Russia], the sanctions are very limited. But in the longer term, if there isn’t a settlement, Russia will become more and more isolated.

By the end of last year, the oil embargo started to have an effect on the Russian budget. How much time do you think should pass before other sanctions start to work?

If you look at the history of sanctions, the only case when they had a fairly dramatic short term effect was with South Africa in the 1980s, when the whole world was unified in imposing these sanctions. But you know, the Russian economy fell probably more than the official figures suggest — during a period when similar countries had boomed because of high commodity prices. Certainly the sanctions are having effects. But these things never operate quickly.

Some sanctions are really hard to enforce. One example — the crude oil from Russia is still being sold to Europe through intermediary firms. Do you think such schemes seriously decrease the damage of the sanctions?

Yes, it dramatically decreases the effects of the sanctions. And going forward, it depends on what happens next. I think if Russia escalates, there’s eventually the potential of secondary sanctions from Europe and the United States. That will be a very dramatic step if that’s taken. The sanctions can be made stronger. So far, for many reasons, the West has chosen not to do that.

What are some options that are on the table right now?

I do not know what’s being said inside the capitals of Europe and the United States. But we know that there is a grey market of goods, for example, semiconductor chips and other things which can help Russia’s military effort. And there are some consumer products that can be cannibalised, taken apart to get similar kinds of chips and machinery that can be useful in building military equipment.

Particularly in these cases of highly sensitive goods that are potentially of military use, the West eventually will look at secondary restrictions, where you put sanctions on the countries that are evading them.

There’s a discussion of doing so with the oil price cap.

But that’ll be the first case. And the oil price has fallen anyway.

It might be hard to completely isolate Russia and turn it into a ‘giant Iran’. The role of Russia in international trade seems to be much higher. It’s not only oil, but also metals and minerals that the West continues to buy even right now.

Well, that’s a very good point, and it depends on where this goes. If Russia uses battlefield nuclear weapons, I would say all bets are off the table with what the West might be willing to do or how people might react. As things stand, the people of the West have not been able or willing to make the sacrifice necessary to have a full cut off. There had been hope of trying to find peace. And for the West, in some sense, making the sanctions stronger is a form of escalation. The West has tried it carefully. But I think if Russia were to continue to escalate, I would be surprised if the sanctions didn’t become much stronger.

You mentioned at WEF that the sanctions won’t lead to regime change. Can they at least help to stop the war?

No, they can’t. As I said in my remarks, sanctions very seldom lead to regime change or help to achieve a strong political objective like that. They generally have an effect. They are a punishment. They can be a tool for making the war effort more expensive and more difficult. But no, they can’t stop the war. Certainly not in any kind of real time. The rare exception, again, was South Africa in the 1980s, where the sanctions were imposed so widely and by so many countries at the same time that it helped to bring the change.

Do you think that these two events — losing the war and regime change — will be connected in Russia’s case?

Oh, I wouldn’t know. You could probably speculate on that better than I can. It depends on what losing the war means. I think hopefully there’ll be an end to the war where both sides agree to peace. There would not be regime change in that context if both sides can portray what they want. Sanctions won’t change a policy that a country holds very strongly in its political sphere. The countries will sacrifice a lot to achieve their political ends. So when trade economists speak of regime change, they’re talking about achieving a major political end through sanctions just in the broad sense of the word.

Taking into account the ‘nuclear option’, it's not very likely that Russia will openly admit losing the war.

It seems extremely unlikely that the West is going to allow Russia to achieve its original war aims. I couldn’t tell you how far things will go in the other direction. I think everyone who looks at this war historically will see it as a huge loss for Russia, a disastrous decision. But that doesn’t mean that the internal propaganda inside Russia will portray it that way. And propaganda is extremely powerful, as you and your newspaper very well know. And, you know, the North Korean leaders portray themselves as doing very well. So if you control the information flow sufficiently and control what’s taught in schools, you can present a picture that is different from what historians will see.

Do you think that even if the war ends soon, Russia will be under severe sanctions for several decades, like Iran?

Well, that’s a good question and it depends on what’s negotiated. Russia may be able to offer something so that the sanctions are released. I’m sure that’s on the table. I would say that if it remains a Cold War and it’s only a temporary peace, and Russia makes clear that it’s planning for another invasion, then of course, the sanctions will remain in place. But that’s all up for negotiation.

Were there some lessons learned from the last sanctions from 2014 that didn’t really stop Russia from preparing for the war?

Very tough question. The sanctions were targeted. But as you say, it didn’t really stop Russia from preparing for the war. There were many studies that showed that the financial sanctions were more effective than trade sanctions had been. They had an effect on the companies that were targeted. They had an effect on Russia. And to say they had no effect on the war… Well, Russia proved very ineffective in its military capabilities. Everyone was surprised. And

Although it’s probably a better guess that corruption in the Russian military was much more important in why the military was less prepared than many had expected.

What do you think is China’s attitude towards the war? It neither showed open support for Russia nor did it join the Western sanctions.

Well, I think what you’re asking is the most important question — what China decides to do. I’m sure China didn’t expect the war to go on like this. It didn’t expect the Ukrainians to fight back so hard. Nor did most Western observers. You know, when Mao opened up to Nixon in the 1970s, he did that because he was afraid that China would become too vulnerable to Russia.

Clearly, things have moved in the other direction. Russia may become so dependent on China that China would hold a lot of power over Russia. They’re going to depend on China for technology, for buying their oil, for many kinds of goods. Russia has become very, very dependent on China.

There’s a bit of an irony, frankly, that Putin claimed to be so concerned about NATO that he’s made himself almost entirely dependent on China. What is it that China wants? That is probably the most important question in determining what comes out of this. I suspect China would like to see an end to the war.

And at the same time — to use this conflict in its own interests.

Oh, absolutely. I wouldn’t expect anything else. Russia is made much weaker and much more vulnerable to China. If I may say, in trying to make Ukraine a colony of Russia, Russia made itself very, very dependent on China.

But not a colony yet?

I’m stopping short of saying that. But it is very ironic. Many people are calling this the last great colonial war. And yet Russia in the process weakens itself so much and cuts off so far from the rest of the world that it doesn’t quite become a colony, but highly dependent on China for everything.

How do you think China perceived the Western response to the war? Will it be threatened if it decides to invade Taiwan?

I think when the US withdrew from Afghanistan, both China and Russia looked at the West as very weak, and thought that they would be able to achieve their objectives in Ukraine and Taiwan. I’m sure the Western response now and how the war has progressed has been very sobering for the Chinese leadership.

They’ve also gotten quite a bit less sabre-rattling. For example, if Japan announced that it was increasing its military spending to 3.5% of GDP before the Ukraine war, China would have been screaming and threatening about this. And now they’ve said nothing.

China still intends on eventually absorbing Taiwan. But I would say that they probably realised they had underestimated Western capabilities and that they may need to take longer to press for their objectives.

In March you wrote that “vastly outspending Russia on defence should be much easier” for the West than to outspend the USSR during the Cold War. Do you think that the period of decreasing military spending in Europe has changed for good?

These things don’t change overnight, but over the next ten years military spending in the West will rise, I predict, by at least 1% of GDP, maybe more. But these things are difficult politically. I think Europe is becoming more aware that it needs to pay for its own defence in a way that it has been completely unwilling to until now.

I think the Russian invasion of Ukraine has been a wake up call. And as far as the United States goes, there is an awareness that the budget is woefully inadequate to pay for projecting military power in the Middle East, Europe, and Asia all at the same time. Right now, the budgets are probably only adequate to do one of those, and I think that’s a source of great concern.

But again, this goes through a lot of politics, and I don’t know the timing, but I would predict that at least 1% of GDP higher defence spending will be broadly seen across Europe, Japan, and the United States over the next decade. The Russian invasion of Ukraine, China’s threats to Taiwan have made even left-leaning progressive politicians appreciate that the global order is changing and they need to respond, certainly against military aggression.

The Ukrainian economy has become very dependent on the financial support it receives from the West. How does it look from the macroeconomic point of view?

The Ukrainian economy is in an extremely difficult situation, according to the official numbers. It is suffering horribly, even beyond the deaths that the missiles and Russian soldiers are causing. The output fell by 30% last year. Inflation is almost 30%. The Russian attacks on the civilian infrastructure have weakened the Ukraine economy and indeed made it very dependent [on the West]. I don’t think this will in any way weaken the Ukrainian resolve to fight the war. If a peace is reached, and especially if Ukraine is guaranteed protection in some way that investors believe, the country can be rebuilt in due course. It’ll take time, but Ukraine can be built back better, so to speak.

Should the Russian oligarchs’ money and the frozen Russian Central Bank’s reserves be used for rebuilding Ukraine after the war?

That question is widely debated. There’s not an easy answer because on the one hand, it’s very just to use the Russian money to help rebuild Ukraine. On the other hand, it undermines confidence in the Western financial system. I would say the Russian Central Bank money is the most vulnerable because it’s clearly owned by the government. The government did this illegal invasion.

Over the last 20 years, this same financial and legal system actually welcomed Russian oil money. Some experts say that’s one of the reasons why the sanctions have been so soft.

The Western legal system differentiates between individuals and governments. And we don’t normally punish individuals for the actions of governments unless we show that they’re actively contributing to the governments. That was not easy to show. I’m sure there will be a lot of soul searching and rethinking of what should have been done.

But on the other hand, I think there had been a legitimate hope that Russia would not move in this direction. I don’t think it’s easy to say after the fact that everyone knew this was going to happen. And so if you think there’s a chance of having peaceful coexistence, it’s understandable to want to engage rather than just block Russia. But clearly, if you had to do it again, the West would have moved much earlier.

Trade doesn’t prevent wars — that was the main surprise for Western political leaders?

Well, if you look at history, having trade does reduce the chances of war. I mean, it doesn’t eliminate it. Germany had a lot of trade before World War Two. But on balance, having trade is helpful for reducing the odds of war. But if someone’s really determined to have war, it can happen.

It’s very hard to second guess every move. You could argue in the other direction, for example, when the West boycotted the Olympics in 2014, maybe they shouldn’t have? Maybe they should have engaged more? Or maybe another way would have been found.

I don’t think we can have a deterministic view of world relations. So it’s hard for me to firmly adjudicate that everything was a mistake. It certainly added up to a disaster. There’s no question about that. The Russian invasion of Ukraine is the biggest destabilisation of the global geopolitical situation since Hitler invaded Europe in World War Two.

Do you think that sanctions will somehow undermine the dollar and euro as the world reserve currencies?

Well, it certainly makes countries like China look for other places to park their money. The problem is there are not so many options.

They’re going to follow US sanctions in the end. So it doesn’t really help to invest in the euro. And investing in China probably has much bigger problems than investing in the dollar.

There’s some discussion. I even had a student write a thesis last year on whether central banks might want to use cryptocurrencies for reserves. That’s a very interesting idea. But right now there is no great alternative to the dollar.

You wrote recently that the fact that the world did not experience a global financial crisis last year was “a minor miracle”. Will there be one in 2023 and how it could affect the Western support for Ukraine if the war goes on?

I certainly think that the risk of having a financial crisis somewhere in the world has significantly risen. Not just in a developing economy — they’re already in a financial crisis, but the risk of having a financial crisis in larger, more systemically significant countries. And by financial crisis I mean that there could be high inflation, pressure on debts, the shadow banking system. I don’t know where it’s going to show up, but I think the probabilities are pretty high.

But I don’t think it will weaken the Western resolve for the war in Ukraine. I think the real question is what the end game is going to look like. And I haven’t met anyone who knows the answer to that. But I think there’s a general recognition in the West that if Russia takes Ukraine, it won’t be the end. And this understanding provides Ukraine with a lot of support.