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The G7’s Bad Idea

Sep 14, 2022
  • Zhou Xiaoming

    Former Deputy Permanent Representative of China’s Mission to the UN Office in Geneva

The Group of Seven decision on Sept. 2 to impose a price cap on Russian oil will have serious consequences for the global economy and the multilateral trading system. In Europe, it has intensified the energy war with Russia, deepening the energy crisis on the continent. Moscow halted natural gas deliveries as winter approaches, and the European Union is reportedly considering historic interventions, including gas rationing and price ceilings.

As characterized by former U.S. energy secretary Dan Brouillette, these measures amount to a Ponzi scheme.

Russia accounted for 41 percent of the EU’s gas imports, 46 percent of its coal and 27 percent of its oil before the Russia-Ukraine conflict. Analysts predict that when Russian gas stops flowing entirely, a bitter economic winter will settle in to the EU. Soaring electricity and gas prices will batter businesses, resulting in numerous factory closures. Meanwhile, many households may, in the face of hyperinflation, be forced to choose between getting food on the table and keeping warm.

Increasingly, high inflation appears to be increasing the risk of an economic recession in the EU. According to the European Central Bank, if Russia cuts off gas altogether, the EU economy would shrink by 1.7 percent next year. Consequently, its economic growth would be expected to slow to 0.9 percent in 2023, down from 3.1 percent in 2022. Designed to cut off the source of funds for Russia’s so-called special military operation in Ukraine, the scheme is likely to hit the EU hard. 

The impact of the G7’s move will go far beyond Europe and affect the wider world significantly. It seems the G7 based its decision regarding the price cap on the assumption that despite huge price cuts Moscow would continue to extract enough oil and gas to keep the world afloat and that any slackening of Russian output would be readily taken up by other countries. As a result, there would be no appreciable supply shortage.

But what if Moscow refuses to play by the G7’s script, which is a far more likely scenario? Moscow has already shown a willingness to cut off natural gas flows to Europe, and Russia’s role as a major global supplier of oil and gas is difficult, if not impossible, to replace in the near term. If Moscow cuts production significantly, no other country — or countries, for that matter — would be able to fill the gap. Pumping at near capacity, most other OPEC+ members are hard pressed to boost production. Inevitably, there will likely be severe supply shortages that send energy prices skyrocketing. Therefore, the G7 price cap could backfire and stoke global inflation.

There are serious doubts about the effectiveness of the policy in practice. However, the world at large should be concerned, even if the G7’s plan succeeds in forcing Moscow to close many of its oil wells, as the West did in 2014 when Russian troops marched into Crimea. It took years for Russia to build back its capacity. One wonders if other countries are capable of developing extra capacity quickly enough. Water in faraway places, however plentiful, is of no use in putting out a nearby fire. Before new productive capacity elsewhere comes on stream — which could be years, not months — the world would be compelled to experience painful energy shortages.  

Apparently, the world at large stands to lose regardless whether or not the price cap works. Either way, it will inflict major collateral damage on the rest of the world. G7 countries, therefore, would be well advised to drop the plan altogether — provided they have the interest of the rest of the world, not to mention their own people and economies — in mind.

Further, the G7’s price cap plan may contravene a number of WTO rules, jeopardizing the multilateral trading system.

 First, under WTO agreements, members cannot normally discriminate between their trading partners; they cannot offer better or worse trading terms to one member and not another. The most-favored nation rule, designed to secure fair trade conditions, requires that a WTO member apply the same conditions on all trade with other WTO members. Grant one member a special favor and you have to do the same for all other WTO members. Similarly, prohibitions or restrictions must apply to all WTO members, be they friends or foes. As the G7’s price cap plan targets Russia only, but not all other members, including G7 countries themselves, the bloc risks violating the MFN rule.  

Second, Article XI of the General Agreement on Tariffs and Trade 1994 stipulates that “no prohibitions or restrictions other than duties, taxes or other charges, whether made effective through quotas, import or export licenses or other measures, shall be instituted or maintained by any contracting party on the importation of any product of the territory of any other contracting party or on the exportation or sale for export of any product destined for the territory of any other contracting party.” 

“Other measures,” which are banned under the WTO’s quantitative prohibition rule, would necessarily include price restrictions, as amply shown in the case of fruit involving the EU and semi-conductors involving Japan at the WTO. A WTO expert panel also determined in a case about rare earth involving China that the coordination of export prices by a business association in the country constitutes an export restriction. It called for the measure to be abolished. In view of these precedents, the G7’s measure on Russian oil is most likely to be ruled in violation of the WTO’s provision on the elimination of quantitative restrictions, since it would result in a restriction of trade.

The G7 may try to justify its move on national security grounds as it did when stripping Russia of MFN treatment approximately six months ago, since the WTO’s national security exception rule, as it stands, is open to abuse. Nevertheless, liberal revocation of the rule would only work to dent the image of G7 countries as advocates of free trade and multilateralism. The G7’s revocation of the rule would be seen as yet another case of weaponizing WTO rules for geopolitical goals, which would undermine the credibility and authority of the world’s top trade body.

And yet, to give the scheme some legitimacy, the G7 is keen to get other countries on board — China and India in particular. The existing sanctions of the West against Russia have continued to be shunned by most non-Western countries and have failed to deliver the expected results. In a desperate bid to make its new sanction work, the G7 seeks to style it as a global stance against war. However, to implicate other countries in such a legally dubious, if not rule-breaking, scheme would be unconscionable. All WTO members, including G7 countries, should play by WTO rules. For the sake of the integrity and survival of the multilateral trading system, it would be only right for China or, indeed, any other WTO member, to resist the pressure to become an accomplice of the G7.

In addition, the G7’s move is anti-market, running contrary to market economy principles that the bloc has been touting for decades. Under the oil price cap plan, markets would no longer be sacrosanct. As the strong hand of government replaces the invisible hand of free markets, unfettered trade in accordance with the law of supply and demand would be undercut, resulting in substantial market distortions. The G7’s approach is antithetical to the principles of a market economy, both in letter and spirit. It amounts to nothing short of a non-market practice.

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