Politics Over Prosperity: Europe’s Self-inflicted Economic Pain

Rajan Katoch Nov 06, 2025

A long-standing conflict is underway in Europe between Russia and Ukraine [backed by the United States (US) led North Atlantic Treaty Organisation (Nato)]. The Nato alliance of the US and Europe is arming and funding Ukraine. The alliance is also pursuing an all-out economic war against Russia through trade and financial sanctions against Russia and Russians. While perceptions on the rights and wrongs of the conflict vary, there are discernible economic consequences for all involved parties, most of all for Europe.

Before the onset of the 2022 Russia-Ukraine conflict, the European Union (EU) stood as one of the most competitive manufacturing regions in the world. The Eurozone’s Gross Domestic Product (GDP) in 2021 was approximately 15 per cent of global output, second only to the United States. Germany, the bloc’s industrial engine, alone generated nearly €4 trillion in GDP, ranking fourth globally.

The EU’s manufacturing sector contributed nearly 20 per cent of the region’s GDP, supported by an extensive network of interconnected industries — from German automotive and Italian machinery to French aerospace and Dutch electronics. It had a robust export base in machinery, vehicles, chemicals, and high-value engineering goods.

There was one critical factor for Europe’s economic strength. Mainland Europe had built up deep economic, especially energy, linkages with Russia after the collapse of the Soviet Union, to its economic advantage. Europe’s energy trade with Russia was a win-win situation for both sides. Russian gas had been meeting up to 40 per cent of Europe’s demand. Pipelines from Russia had made gas cheaper and more plentiful in Europe.

Much of the EU’s natural gas and crude oil came from Russia through well-established pipeline networks such as Blue Stream, Turk Stream, Yamal Europe, and Nord Stream. These supplies maintained stable production costs for energy-intensive industries, particularly across Germany, the Netherlands, Austria, and Italy. This was indeed the bedrock of the competitiveness of European industries.

Disruption Of Stability: The Sanctions Regime Reversing longstanding policies of mutually beneficial economic cooperation, in 2022, European leaders chose to actively engage in the Ukraine conflict and go along with the US-led sweeping economic boycott of Russia and all things Russian. Conceived as punitive tools to degrade Russia’s economy, these unprecedented Western sanctions cut off links with Russia’s economy, particularly trade, banking, energy, and industrial sectors. Washington’s stated aim was to destroy the Russian economy and ‘turn the ruble into rubble’.

Energy and finance were the hardest hit by the Western sanctions regime. Energy cooperation with Russia was abruptly cut off. The sanctions were followed by the mysterious sabotage of both Nord Stream pipelines, enabling the import of gas from Russia to Germany. This ensured that even if the conflict were to end, gas supply from Russia would be difficult to restore.

The Western ban on Russian energy products reshaped global supply flows. Foregoing its largest energy partner forced Europe to turn to alternative sources of supply at much higher costs. Within a year, the bloc shifted from pipeline gas from Russia priced at USD 4–6 per MMBtu to imported liquefied natural gas (LNG) from the US and Qatar costing USD 14–15 per MMBtu.

The impact was immediate and severe. Energy import bills more than doubled, while industrial gas prices rose nearly fourfold. By mid-2025, despite some stabilisation, European electricity prices remain three times their pre-war average.

The energy crisis cascaded into an inflationary shock. Driven by surging energy and food costs, Eurozone inflation soared from the relatively stable pre-sanctions levels of about 0.7 per cent in 2020 to its current level of about 2.1 per cent, three times higher than before. Europe’s manufacturing competitiveness has eroded, particularly in chemicals, steel, and automotive production, where energy accounts for a significant share of input costs.

Further, the continuing and direct involvement of the NATO alliance in keeping the conflict going means that for Europe, there is now an escalation in threat perception from Russia. As a result, European countries are spending a lot more on arms. Defence spending that was about 1.5 per cent of GDP in 2021 is now at 2 per cent. The US has extracted a commitment from European countries to raise it to 5 per cent in the medium term. Further, under the Trump Administration, Europe is now expected to pay for arms shipments to Ukraine that were previously funded and supplied by the US. It goes without saying that the increase in these outlays would be at the expense of spending on development and welfare of the European people.

Europeans also have to bear the burden of the Ukrainian refugee influx (estimated to be about 6 million) caused by the displacement of populations due to the conflict. And at the end of the war, European governments will be expected to contribute substantially, if not entirely, to the reconstruction of Ukraine.

The Industrial Fallout Europe’s industrial base — long regarded as the foundation of its prosperity — has been hit hardest. The chemical industry, Europe’s largest manufacturing employer, saw energy costs double from €3 billion to over €6 billion annually within two years. Major producers like BASF and Dow scaled back operations or shifted investment abroad, particularly to the United States, where energy prices were one-third as high.

Automobile production, already challenged by electrification costs, suffered further setbacks due to expensive raw materials and severe supply chain disruptions. Palladium (of which 40 per cent of global supply came from Russia) became scarce, and the cost of nickel and aluminium — also Russian exports — spiked by over 30 per cent.

Germany’s auto production fell 8 per cent by 2024, while exports from Europe’s automotive sector declined 12 per cent. In particular, to a dispassionate observer, it seems to be an economic hara-kiri for Germany to be deliberately cutting off the energy links that had made it a global manufacturing powerhouse. At the end of it all, it is the common man in Europe who suffers in the form of layoffs and rising prices.

Russia’s Resilience And Economic Reorientation On the other hand, contrary to initial predictions of collapse, Russia’s economy proved surprisingly resilient. There is certainly economic and fiscal pressure on Russia. The availability of high-technology inputs for key industries, as well as consumer goods, is being squeezed. High military expenditures are raising budgetary deficits.

Nevertheless, being a large country with immense natural resources, Russia has been able to tide through the sanctions regime so far. Russia has successfully reoriented its trade and energy links away from Europe towards China and countries of the Global South. In the medium term, the importance of being a commodity-producing country in the new world economic environment is only going to grow.

Because Russia is endowed with vast oil, gas, and key mineral deposits that are needed for the modern world to function, excluding Russia from the Western economic order may lead to more painful adjustments for the West than they had anticipated. The forces of demand and supply will ensure that, sanctions or no sanctions, commodities and resources will find their way to where there is a requirement.

The IMF now estimates Russian GDP growth to be 4.3 per cent in 2024, surpassing much of Europe. To make up for the loss of European markets, Russia has successfully redirected oil and gas exports to Asia. 80 per cent of crude now is exported to India, China, and Turkey. Despite discounted prices, total fossil fuel revenues in 2024 reached USD 120 billion, close to pre-war levels of USD 160 billion.

Meanwhile, Russia’s policy of import substitution revitalised domestic manufacturing, while ruble stabilisation and state-led demand have kept unemployment low at 2.2 per cent. New trade channels with non-Western countries have offset much of the loss of the European market.

Further, in Russia, technological advances seem to have been spurred by the war. Russia has developed new weapons (Burevestnik cruise missile and Poseidon underwater torpedo) powered by miniature nuclear reactors. This may accelerate the development of potential civilian applications of energy generation by small modular reactors, particularly in remote areas and in cases of stand-alone heavy energy consumers like data centres.

Russia’s economic pivot has exposed the limits of sanctions when imposed against a resource-rich, self-sufficient economy. Instead of isolating Russia and choking its economy, the sanctions mainly resulted in the creation for Russia of alternative financial and trading systems centred on Asia.

The United States: Short-term Benefit The United States, as the leader of the Nato alliance, is actively driving the EU’s hard-line economic and societal sanctions against Russia. The US is a gainer from the conflict in the short term. It has created a huge additional demand for the output of its weapons industry.

The US government has already reportedly provided USD 70 billion in military assistance to Ukraine. This is a bonanza for the US arms manufacturers, who include the biggest names in US industry like Boeing, Raytheon, Lockheed Martin, and General Electric. Sales are brisk, without any country risk, as their own government and European governments are directly underwriting the orders.

In addition, the US-led Ukraine war-related sanctions have at one stroke successfully scuttled the growing European-Russian trade relationship and strengthened American economic links with European markets. By disrupting the supplier-consumer relationship between Russia and Europe, the US has created a market for the export of its gas, at the expense of Europe. European economic dependency on the US has increased.

Economic Consequences Of Political Choices The economic blowback on Europe from politically motivated decisions is now widely acknowledged, even within Western policy circles. The share of the eurozone’s GDP in global output has declined from 15 per cent pre-sanctions to 13 per cent currently — that is huge!

Inflationary pressures and higher borrowing costs have slowed recovery. The International Monetary Fund (IMF) 2025 outlook forecasts Eurozone GDP growth at 1.2 per cent in 2025 and 1.1 per cent in 2026, well below historical trends. The economy of the European powerhouse Germany is stagnating, with projected GDP growth now down to 0.2 per cent from a robust 3.2 per cent in 2021. Even as governments attempt to accelerate green industry transitions, high energy input costs have rendered much of European manufacturing uncompetitive relative to counterparts in the US and Asia.

The sanctions against Russia reflected Europe’s political decision to stand firmly with the US-led Western alliance, regardless of the consequences on their own economic well-being. The decisions made since 2022 have weakened Europe’s competitive advantage, reduced its policy autonomy, and deepened strategic dependence on the United States.

The irony is that the very actions designed to isolate Russia have destabilised the foundations of Europe’s own economic resilience. The supply disruptions, rising defence budgets, and refugee burdens have created avoidable economic pain.

Europe finds itself confronting a new economic reality: slower growth, heavier debts, and growing transatlantic dependency. Solutions are known, but European policymakers have got themselves into a quagmire that begs no easy way out. As far as Europe is concerned, politics seems to have trumped prosperity!

First published in BW Businessworld, November 6, 2025.

(Disclaimer: The views expressed in this article are those of the author and do not necessarily reflect the views of the publication.)