There has been a lot of talk recently about how the markets are punishing the Russian Federation for its actions in Georgia. Dan Drezner, for example, writes: “An estimated $21 billion left Russia last month, and the RTS Index has declined by more than seven percent this month ... this is a pretty high price to Russia to pay for creating two unrecognized buffer states.”
It isn't just political scientists. Investors also believe that the markets punish aggressors on their own.
I am not so sure. No, let me be stronger. I am almost positive that Dan Drezner is wrong about the economic damage that Russia is taking from its actions, even if I agree with his assessment of Russia’s weak political position.
Markets do not punish successful aggressors. Other countries can impose sanctions that punish aggressors, and that will hurt the markets. That logic, however, runs exactly the other way from the sanguine belief that our brave new world of globalized markets contains automatic mechanisms that contain interstate war.
This chart shows the evolution of four different Russian equity indices. The RTS-1 that Dan referred to in his post is in dark red. The date that the Georgians started the war (August 8th) is represented by the bright red vertical bar.
Russian indices were in decline well before the war started. If anything has happened since, it is that the decline has slowed. This is not consistent with the hypothesis that the markets are punishing Russia for the war.
Below the fold is a closer look at the same data. The closer look makes it even clearer that the markets are not punishing Russia for invading and carving off chunks of Georgia.
The markets reacted badly to the outbreak of war on August 8th. They did not care about the Russian counterattack on August 9th or its naval assault on August 10th. They liked the ceasefire agreement on August 12th. Indices dip a little on August 26th, when Russia recognizes Abkhazia and South Ossetia, but then immediately start heading back up.
That's it for easily apparent reactions to war-related events.
There are two non-easily identified jumps in the markets. They don't like something on August 19th. They like something on August 27th-28th. Then they don't like something on September 3rd.
I have no idea why the markets bounced back after the Russians recognized the new Caucasian territories. If I had to guess, I'd say it's because they recognized that their would be no sanctions forthcoming from the E.U. or U.S., but that's a shot in the dark.
On the other hand, I have a very good idea why the markets fell on September 3rd. First, the energy minister announced that oil output was lower than expected. Second, BP finally announced that it would pull the British CEO of its TNK-BP joint-venture in Russia by the end of 2008, and (via sales of new shares) shrink BP's stake in the venture from 50% to 25% “without full compensation.”
Shares of BP rose, because the agreement finally ended the uncertainty over how much BP would lose, but the fact the BP would lose almost half its stake in the venture has unsettled the markets. Would you want to invest somewhere that the government could transfer your property rights to its private allies without a credible threat of sanction? ICSID and the like protect you from government expropriation ... but the Russia Federation has discovered some very interesting work-arounds that allow for private expropriation.
(I believe that the U.S. should encourage sovereign wealth funds to invest in the United States in order to protect our companies against these sorts of shenanigans, but that's a different issue.)
In short, the markets did not fall because they are sanctioning Russia for scarfing off parts of Georgia. Nor did they fall because the West sanctioned Russia for scarfing off parts of Georgia. Rather, they fell because the West failed to sanction Russia for scarfing off parts of the petroleum company formerly known as “British.”
There are many good reasons why you shouldn't be scared of the Russian Federation or worried about its actions in the Caucasus. The idea that markets will protect you against aggression, however, is not one of them.