Both in Russia and in the West, many analysts argue that sanctions are ineffective. In Moscow this argument is repeated almost constantly with regard to the Western sanctions imposed on Russia after its annexation of Crimea in March of last year. Why is this so? Because one of the few things that serious people learned during the 20th century, to the point of virtual consensus, is that sanctions do not work except to salve the consciences of offended but risk-averse statesmen. It enables such statesmen to be seen to “do something” when passivity is embarrassing but doing something is either too dangerous or thought to be incommensurate with the threat to the national interest.The academic literature, particularly in the West, overwhelmingly supports this verdict, even as it accounts for the very few noteworthy exceptions (apartheid South Africa, Bolivia, perhaps Serbia) by specifying the extremely unusual conditions that enabled sanctions to work in those cases. Thus, it is still de rigueur for many to refer to the classic essay by Robert Pape, published in the International Security more than 16 years ago, as a kind of proof text. Pape analyzed the period from 1933 to 1990, a time when Western sanctions against various countries could be offset by help from the Communist bloc. It was easy to understand why, until the end of perestroika, U.S. sanctions against Cuba were ineffective, and, indeed, why they helped the Castro regime politically. It was nearly as easy to understand why economic sanctions and political restrictions imposed almost exclusively on peripheral countries (North Korea, Ivory Coast, Iraq, the Democratic Republic of the Congo, Sudan, Myanmar) did not work as intended either. The level of economic development in most of these countries put a significant portion of their populations on the ragged edge of survival anyway; if someone doesn’t possess something in the first place, she or he is not afraid of being deprived of it, especially if the bond between leaders and masses is weak to begin with. Sanctions that were supposed to target leadership cadres while avoiding general populations therefore rarely worked as intended.The old consensus may have been justified (or not), but it is justified no longer. Things have changed. Today, thanks in part to greater global economic interdependence and the technical ability to selectively target that interdependence, sanctions have acquired new efficacy as a policy tool. What used to be exceptions to the disutility of sanctions—South Africa, because white people there actually cared about what Westerners thought of them; Serbia, because serious coercion accompanied serious sanctions—have become much more the rule.Consider Iran. Apologist narratives notwithstanding, Iran would not be negotiating with the West had powerful sanctions not forced it to the table. Whether the negotiations work is another matter; many factors play into that prospective outcome. But sanctions worked as intended.Now consider that Moscow today lacks even the allies Havana had in the 1970s; that its elite can be surgically targeted by sanctions as never before; and that its economy is vastly more dependent on commodity exports today than the Soviet economy ever was.Most Russian politicians underestimate the cumulative significance of these crucial facts, which render Russia the only European country in the past twenty years to find itself in such a sanctions-vulnerable situation. Moreover, Russians are not in the mood to hunker down and suffer because they are in thrall to abstractions. They are not like devoted Islamists, and Vladimir Putin is not their ayatollah. Even if they hate America and are contemptuous of Europe, the citizens of the Russian Federation long ago learned to love money much more than Europeans and even Americans. Putin was able to wrap himself in the tricolor Russian flag over Crimea for a while, before any cost was reckoned. That has already proved an ephemeral phenomenon, and things will only get worse. Let me now explain why and how.The sanctions imposed on Russia last year started out looking classically punchless to many. Since Russia’s actions qualified as aggression according to at least three paragraphs of Article 3 of UN General Assembly Resolution 3314, adopted on December 14, 1974, any country that recognizes this fact has the right to take necessary “countermeasures.” Thin international legalities aside, the European Union and the United States had to take some countermeasure for political reasons, but a direct military response to a nuclear power was not an option. Supplying Ukraine with weapons did not seem like a good idea either to those in positions of responsibility, since the integrity and institutional depth of the Ukrainian government left a good deal to be desired at the time. It was also obvious that, because of Russia’s status as a permanent member of UN Security Council, countermeasures could not be executed as UN-sanctioned actions. These factors determined both the form and scope that Western sanctions took by the end of 2014.The Western sanctions were and remain in full accord with the current international legal regime. As long as they do not violate WTO criteria (and they do not), they are both reasonable and legitimate. What really matters, however, is whether they are effective, and to be effective politically they need to cause specifically targeted economic pain and, at the same time, not cause proportionate pain to the sanctioning states themselves.As to this last criteria, there is no doubt that the consequences of sanctions for Russia will be much more significant than they will for either the European Union or the United States. Though officials in Moscow insist that the profits lost by the Western nations may equal, if not exceed, €1 trillion, this is either pure propaganda, delusional wishful thinking, or some curious combination of the two. The restrictions on the supply of equipment, the freeze on new loans, and the cutting of ties with several Russian companies are unilateral Western actions that harm only Russia. With regard to food “countersanctions”, such a ban may reduce Russian imports from EU economies by not more than €6 billion per year, which represents only 4.5–5 percent of Europe’s farming exports and 1.2–1.3 percent of the European Union’s overall agricultural production. The very fact that the Russian GDP at the current exchange rate is valued at about €1 trillion, while that of the EU member states is more than €13 trillion, shows that the sanctions are much more threatening to the Russian Federation than they are to the European Union.More critically, European and American sanctions damage Russia in at least four ways, and all of these ways are gaining impact with the passage of time.First, most painful to Russia are the financial sanctions. Russia throughout the 2000s remained an economy with high inflation, and therefore with high interest rates. At the same time, the ruble/dollar exchange fluctuations were relatively small during the whole period (30.6 rubles per dollar in early 2002, 24.4 rubles per dollar in early 2008, and 33.1 rubles per dollar in early 2014). In such circumstances large Russian companies listed on foreign stock exchanges and showing healthy financial results easily obtained three- to ten-year loans from foreign banks at 3.5–5.5 percent per annum, instead of paying 12–14 percent for one- to two-year loans from Russian banks. As a result, by the beginning of 2014 Russian corporations owed foreign creditors more than $678 billion (22.4 trillion rubles), while borrowing from Russian banks totaled only 19.3 trillion rubles. Most of these foreign loans were constantly replaced by new ones; in other words, the corporations borrowed money not just to acquire additional capital but also to pay off older obligations—but their overall amount of debt grew steadily by $60–70 billion per year from 2009 to 2013.The Western ban on issuing new loans to major Russian banks and a number of state-owned corporations has therefore put them in a very difficult position. They have until the end of 2016 to repay about $270 billion in loans and interest, at least $200 billion of which they had hoped to refinance. Lacking that option has caused a sharp decline in new investment; corporations have lined up to obtain loans from state reserve funds instead. But the rates are high, the capital is limited, and they still need to buy dollars to repay their Western creditors.Indeed, the Russian corporations’ attempts to buy dollars to repay their hard-currency denominated debts have provoked a constant and at times precipitous decline in the ruble’s value. The Central Bank spent more than $70 billion from March to December 2014 (thus lowering its reserves to $390 billion) to support the national currency, but allowing the ruble to float caused it to depreciate from 32 rubles per dollar in February to 67 in December. This made debt-servicing much more problematic; if recalculated into rubles, the foreign debt of Russian corporations and banks increased by 11.6 trillion rubles, 50 percent more than the total profits of the Russian corporate sector for 2013.This means that Russian companies will have no choice but to reduce investment even more dramatically in 2015. They will cut their workforce, too, while the government, forced to bail some of them out, will embezzle at least half of its reserves. By next winter the government will face extremely limited elbow room for similar financial maneuvers.Second, the sectoral sanctions are having a very serious effect, as well. Throughout the 1990s and 2000s, Russia became seriously de-industrialized, and a large number of critical components and technologies now need to be imported. In the space industry, for example, which is subject to the sanctions, every communication satellite consists of more than 60 percent imported elements. The share of imported electronics used in Russian military equipment exceeds 50 percent, too. The materials used in the semiconductor industry are 70 percent produced abroad. In fact, Russia will not be able to carry out its military sales contracts as soon as existing agreements expire. The country is also unable to import any modern military equipment, as the endgame over the French Mistral ships shows.Most critically, almost all new Russian oil and gas fields have been put into operation with the use of technologies provided by companies like Halliburton or Schlumberger, which are now banned from participating in offshore Arctic drilling as well as in the extraction of shale gas. All that Russia has managed to achieve so far is to reach oil and gas production levels common for the RSFSR in the late 1980s. By comparison, according to the BP Statistical Review of World Energy 2014, today Kazakhstan extracts 3.4 times more oil and 3.6 times more gas than in the late 1980s. Russia, with its dwindling deposits put into operation back in the 1970s and the 1980s, desperately needs new resources, but their development is profoundly jeopardized by the sanctions. There will thus be a noticeable reduction (by at least 6–10 percent) in oil and natural gas production by 2016. Given that oil- and gas-connected incomes accounted for nearly 52 percent of Russian Federal budget revenues in 2013, this is of extreme significance.Third, there is now a marked and ongoing disruption of the consumer market due to both Western financial constraints and the Russian “countersanctions” that followed. On the one hand, the appreciation of the dollar and the euro against the ruble has caused higher inflation. In Russia imports account for 40 percent of all foodstuffs, 60–70 percent of clothing and footwear, 75 percent of medical equipment and medicines, and close to 100 percent of electronic hardware, office equipment, and mobile phones, and the depreciation of the national currency immediately provokes a rise in prices. Local producers, using the situation to their advantage, also raise prices in line with those of the imported goods.The doubling of the dollar exchange rate from July to December 2014 has not yet led to a proportionate increase in prices because the conclusion and execution of contracts require four to six months to play through the system, but beginning in February 2015 the effect will become obvious. Inflation in 2015 cannot stay below 20 percent. Nor will real disposable incomes increase. The decline of the ruble exchange rate may compensate for the effect of lower oil prices and a reduction in exports; because export duties are denominated in dollars, this year’s budget will receive more rubles. So the government, as Putin emphasizes, will meet its obligations to state employees. But these employees will be paid the same number of now-devalued rubles as last year, and they will not buy as much. The private sector, faced with a full-scale crisis, will not raise wages. Together this portends a significant drop in living standards.Russian “countersanctions” will only exacerbate the problem, since the ban on the import of foodstuffs will provoke an even sharper rise in food prices, which account for about 32 percent of an average Russian’s overall spending. By the end of this year, one can assume that this share will grow to at least 40 percent, which corresponds to the situation in Belarus in 2014. By trying to “punish” the United States and the European Union, Russian authorities delivered a serious blow to the neediest portions of their own population.It is difficult to know whether all these trends will catalyze social protest in Russia—probably not. But they are likely to generate additional tension in society, which could be disadvantageous for the authorities in the wake of the parliamentary elections scheduled for the fall of 2016.Fourth, the sanctions complicate Russia’s relations with its allies inside the Customs Union and newly formed (in effect since January 1, 2015) Eurasian Economic Union. By itself, the EAEU is a strange construct; most of the trade within it (in oil and gas) is not subject to the common customs regulations; the decisions of the Court of the Union have only recommedative power, allowing the system to continue until its first major quarrel. Sanctions have already generated considerable controversy among Customs Union members. On the one hand, Belarus and Kazakhstan have sought to integrate with Russia largely because it was a WTO member and they were not; therefore the alliance with Russia promised easier access to the world market. But that advantage now seems unlikely to accrue due to the West’s rapidly worsening attitude toward Moscow.On the other hand, the promised single economic space turned out to be broken. Russia, blocking supplies of foodstuffs from the European Union, effectively cut Kazakhstan off from them as well, in the belief (often justified) that agricultural cargo bound for Kazakhstan might be smuggled while transiting Russian territory, or might be re-exported back to Russia under different terms. As a result of similar concerns, the border between Belarus and Russia, which didn’t exist for practical purposes for many years, has turned into a strong line of monitoring and inspections.Thanks to the sanctions, therefore, by the end of 2014 the Customs Union was for all practical purposes nonexistent. Russia’s share in Kazakhstan’s external trade reached an historic low of 6.9 percent. Presidents Nazarbayev and Lukashenko let their irritation be known publicly, and openly questioned the fate of Putin’s vaunted post-Soviet integration project.The purpose of sanctions is to generate economic pain for political purposes, but the translation process is tricky. Nevertheless, there is reason to think that the sanctions have already had a major impact both on the Russian economy and on Putin’s geopolitical projects. That is why since November Moscow has tried to undermine the sanctions regime on a bilateral basis. At the same time, the Kremlin is undertaking huge deals inside Europe, corrupting far-right politicians, and trying to persuade leaders of Central European countries most interested in cooperation with Russia in the energy sector to line up with its policy.Some of these efforts have made headway. However, they do not offset the growing impact of Western sanctions, which go to fundamental economic elements but have a gradualist nature. In other words, while the sanctions are meaningful, they do not act fast. It will take at least another full year for them to really hit home. The Russian oil industry will not experience the full impact for perhaps two years, given the lead times natural to the industry. The food “countersanctions” have more obvious and immediate outcomes, but even their impact will become clear only in conjunction with the financial ones. Therefore, the real impact of Western sanctions cannot be evaluated earlier than mid-2015.There should be no problem waiting that long. Western financial losses, often mentioned by many European businesses, are not critical. The volume of exports from the European Union to Russia from January to November 2014 decreased by 8.9 percent compared to the previous year. If the trend continues it will mean a loss in 2015 of around €11 billion in EU exports. But that is out of an overall volume of €1.75 trillion—in other words, not more than 0.7 percent of the total. This is a rather small amount to exchange for European principles and values.Even if one assumes (which it is unrealistic to do) that Russia, for example, will block pipeline gas supplies to Europe (which would deprive it of 12 percent of its exports and turn the largest Russian company, Gazprom, with its 460,000 employees, into a money-losing business), the European Union can replace Russian supplies within a year. For this it will need to reduce consumption by 15–30 billion cubic meters, and to increase North Sea production by 20–30 billion cubic meters and in North Africa by another twenty billion. The rest may be easily purchased as liquefied natural gas (LNG), since the re-gasification facilities in the European Union are these days three times larger in capacity than the actual amount of LNG imports. All this will cost EU economies €20–25 billion per year, but Russia will lose much more.That comparison bears on a non-economic point, one having to do with political language. The constant talk in the West about a supposed new Cold War with Russia should be terminated, not least because in a rerun of the former showdown there is little to worry about. Back in 1984, the Soviet economy was one and a half times larger than that of West Germany, up to a million Soviet soldiers were stationed in Central Europe, and the Warsaw Pact was backed by a communist ideology widely respected if not always supported throughout the world. Nowadays Russia’s economy is ten times smaller than that of the European Union (at current exchange rates); the country depends totally on oil and gas exports and imports a huge share of vital goods; and it possesses no true allies, as the recent case with the sanctions shows. With the current position of the Russian Federation and the current degree of its elite’s incorporation in the Western world it would be quite easy to win a new Cold War, if there really were one.What about the long-term consequences of the sanctions? They may help the West in due course to restore the territorial status quo in Ukraine, but that outcome depends mainly on what Ukrainians do, not on what the West does. It is doubtful, however, that the sanctions can touch off regime change in Russia itself. That is because Russians do not tend to blame government for economic hardship, anymore than they credit government for economic success. (It would take a whole book of history and collective psychoanalysis to explain why this is, so let me leave it as an assertion here.)Political forecasting is harder than economic forecasting, so let me start with the latter. During 2015, sanctions will cost Russia in one form or another not less than $100 billion. Capital flight will exceed $200 billion. The ruble will continue to decline, approaching the level of at least 80 rubles per dollar. The economy will contract by no less than 8 percent, while real disposable incomes will contract even further.As to the proximate political impact, by the end of 2015 Putin’s policies toward Ukraine will be supported by less than half of Russian citizens despite the lack of street protests. In this situation, the West should offer Mr. Putin a face-saving exit plan. That plan can consist of Russian acceptance of a UN troop presence in eastern Ukraine and desisting rebel support. Crimea could be turned into quasi-sovereign territory under a UN mandate with its final status to be resolved by referendum in twenty years time. The details can vary but the essence remains the same: The West needs now to reflect on the conditions of a “new Dayton”, one in which sanctions alone suffice to set the table.The Russian leadership cares most of all about retaining power and continuing its institutionalized kleptocracy. In the end it will drop the cases of the Donbass and of Crimea, but it might take time, and the regime may be agile enough to survive the retreat. Note that even after signing the Dayton agreements Slobodan Miloševic remained Yugoslavia’s leader for another five long years, and he might have been there even longer had he not made so many more mistakes. Putin will not repeat these kinds of mistakes because he and his close circle are too little obsessed with ideology and too much with money to do such things. The West should maintain the sanctions, should not misstep into the rhetoric of a new Cold War, and above all needs to draft a grand strategy with respect to Russia for the “post-sanctions” period. It takes a great deal of skill to take “yes” for an answer. The West has not yet undertaken that task.
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Appeared in: Volume 10, Number 4
Published on: February 2, 2015
Published on: February 2, 2015
Policy ShopYes, Sanctions Work
The old wise-man consensus about the inefficacy of economic sanctions is truly old. Turns out they often work pretty well these days.