What It Takes For Russia’s Sanctions To Have A Fighting Chance To Work

104 04/07/2022

The groundswell by the advanced democracies applying sanctions on Vladimir Putin, his cronies and various elements of the Russian economy following Moscow’s initiation and intensification of military attacks on Ukraine in February 2022 is beginning to have the hallmarks of a coordinated sanction strategy unprecedented over the last half century. Think: much of the world’s response starting in the 1960s to South Africa’s apartheid regime.

But economic history teaches us that the objectives sought, and the types of sanctions applied, differ greatly—often quite so—across cases. However, one commonality stands out: there is enormous complexity involved in the application of—and results achieved from—sanctions. The multi-dimensionality required, exploiting the interconnectedness of outcomes, and the rapidity in which the effects of sanctions change, can make achieving success more challenging than winning at the game of Whack-a Mole.

At the moment, it remains to be seen if the regime of sanctions being put in place on Russia will actually alter the trajectory of Putin’s actions in a hoped-for direction. They could well stiffen his resolve.

Russia, indeed the former Soviet Union—which Putin clearly is intent on recreating—is not South Africa. Far from it. It would be a tragic mistake to draw many parallels.

I say this as someone who is not a native of Ukraine, Russia, or anywhere else in the Commonwealth of Independent States (CIS), and the other post-Soviet, Eastern, Central and Southern European states, but as one who has been working on the ground in almost everyone of these countries since 1997.

And I’ve also had the good fortune of working extensively in South Africa; indeed in 25 of the 54 countries on the African continent.

Sanctions’ Enforcement is Not Equivalent to Their Success

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The use of international sanctions over the arc of history—trade embargoes, financial penalties, export controls, travel restrictions, consumer boycotts and other means to impose punishment on and compel policy changes from adversaries—dates back many centuries. Yet, as ingenious and sophisticated as these regimes have become and despite their ubiquity, their effectiveness in achieving the outcomes sought remains dubious.

This is not the result of ill-defined or undesirable objectives; rather, it is because inducing alteration in human conduct in specific directions through employment of incentives and disincentives in complex political, economic and social settings with multiple actors in play, whether apparent or potential, is far more art than science.

Thus, it will be truly remarkable if the current sanction regime being imposed on the Kremlin—which is changing almost daily—results in Russia and Ukraine going back to the status quo ante, let alone Russia being made worse off and/or forced to make reparations to Ukraine. After all, assessing the performance of sanctions is not simply the extent to which they are enforced. Rather, it is the degree to which they accomplish their hoped-for objective: a change in policy and conduct.

This cause-and-effect linkage is a point many observers do not fully understand.

Are Sanctions an Over-Used Tool?

Most of us who have had the opportunity to serve in senior international economic or foreign policy positions in government have come to believe there is an overuse of sanctions and false expectations of what they can achieve. Of course, in the midst of a crisis, it would be rare if one doesn’t feel politically compelled to act. Doing nothing simply is not option.

The use of military force, especially putting boots on the ground, is the very last choice. Suffice it to say, in the case of Ukraine, systematic deployment of NATO troops or armaments is about as far off the table as possible, inasmuch as Mr. Putin’s has made clear that his fear of NATO’s encroachment to the Russian border is his “hot button.” Barring cataclysmic actions by him, bringing in NATO at this juncture would arguably fan the flames of war.

Therefore, often the imposition of sanctions looks like a reasonable option. But probably too often. History has taught us that the effectiveness of sanctions—even if they are scrupulously enforced—rarely bring about the sought-after outcomes: alteration in the targeted adversaries’ decision-making calculus.

It is not that sanctions are poor instruments; they are just insufficient. Even if carefully designed and executed, it takes time for sanctions to work through complex institutional and political economy environments. It is rare for sanctions to produce quick results. The result is there are significant challenges in maximizing the impact that they can have.

Challenges of Formulating and Executing Sanctions

Gaming Sanctions’ Imposition. First, there is the issue of gaming the timing and speed of the imposition of sanctions—whatever tools are chosen. The announcement per se of forthcoming sanctions is meant to send a signal to achieve deterrence. But this works only if the follow-through on the implementation of the announcements is credible (i.e., actually carried out); the specific sanctions are well chosen and are aimed at targets that will “move the needle” of the adversary (or adversaries); and the timing corresponds to assumptions about forthcoming adversarial moves.

On this last point, in the case of Russia, it certainly seemed obvious (at least to us military novices) in light of the speed, amount and location of troops and equipment that had encircled various points around Ukraine’s borders that Putin was increasingly prepared to pounce. At that juncture, to think sanctions—arguably of any sort—would have served as an ex ante deterrence of an invasion seemed myopic.

To be even more frank, for those of us who have worked extensively in Russia on economic policymaking at the highest levels and interacting with Putin’s most senior associates in government, it was hard to believe he was not poised to invade Ukraine no matter what sanctions were in the wings or applied.

Staging the Implementation of Sanctions. Second, despite this, there needs to be a strategy of staging the application of successively tougher sanctions based on a game-theoretic basis. Particularly when Putin seemed destined to attack Ukraine it was wise to hold off ratcheting up from the get-go.

In this regard, carefully defining at the very outset both a (i) rank-ordering of the content of potential sanctions and a (ii) rank-ordering of the targets to be subject to such sanctions is crucial. To this end, the appropriate focus should be on identifying which firms, banks, individuals and other institutions within the country (as well as abroad) would be not only the most susceptible to be harmed by sanctions but that the costs engendered would also have the highest probability of eliciting the desired outcomes on the adversary, that is, a specific change.

These are, of course, hardly trivial or uncomplicated decisions to be made. Ultimately, handling them must rest on specific assumptions that must prove to be sound about adversaries’ reactions. It must also be the case that whatever sanctions are chosen, they can, in fact, be enforced in operational terms.

What It Takes For Russia’s Sanctions To Have A Fighting Chance To Work

These are the significant challenges policymakers executing sanctions face in practice—both their application and maximizing their impact.

Building and Maintaining Coalitions. As a general rule, the more comprehensive sanctions are, the more sectors that are covered by sanctions, and the tighter the coalition of the countries imposing and enforcing such sanctions, the probability of their effectiveness increases. Yet, these are general precepts. There is no cookie-cutter formula to guarantee success. Complexities abound.

To take perhaps the most obvious issue is the need to prevent “leakage,” that is, a failure of the sanctions to bite completely. The worst case would be if there is “cheating” among the parties imposing the sanctions. Hypothetically, suppose the G7 countries were to agree to place an embargo on their purchases of oil from Russia in order to deprive the Kremlin from substantial dollar earnings: Russia’s oil sales account for 40% of the country’s federal revenues. But, say, hypothetically, Germany actually increases its oil purchases from Russia. The resulting economic squeeze on Russia from the G7’s actions could become de minimis.

More typically, would be “leakage” from countries that are not party to the imposition of sanctions. Suppose the G7 held together on their commitment to refrain from buying Russia’s oil, but the Chinese step in to purchase the then-excess supplies from Russia.

Another complexity of sanctions regimes is it’s not always the case that allies apply the same sanctions to the same foreign entities. After all, these are decisions made at the national level. This is the case with respect to the current sanctions imposed on Russia by the U.S., U.K., Canada and the EU, among others.

Selecting from the Menu of Targets. In the case of placing sanctions on Russian individuals, there is congruence among the U.S., U.K. and EU on the freezing of foreign-held assets of Putin and Sergei Lavrov (Russia’s Foreign Minister) and on these two leaders being prohibited from traveling to those countries. By the same token, Russia’s Defense Minister and the head of the FSB (the successor to the KGB), face both asset and travel bans on the part of the U.S., U.K., and EU.

However, while the EU imposed asset freezes and travel bans on all 351 members of the Duma (Russia’s parliament), the U.S. has imposed such sanctions on only the head of the Duma. The U.K.’s sanctions apply only to Duma members who voted to recognize Putin’s declaration that Ukraine’s Donetsk and Luhansk regions are “independent.”

With respect to Russian companies, the U.S. is restricting the ability of some of the country’s most strategic firms from raising funds in U.S. markets; namely, the energy giants Gazprom, Gazprom Neft, Transneft and RusHydro; the shipping and rail firms Russian Railways and Sovcomflot; telecom company Rostelecom and the diamond mining firm Alrosa. The U.K. has banned Aeroflot from U.K. airspace and has banned sales, operations and investments by Russia’s largest defense manufactures and the country’s largest shipbuilder. The ban by the EU includes some of Russia’s largest companies in armaments, truck manufacturers, and in the shipbuilding and submarine building sectors.

And all three of the Western nations have placed prohibitions on exports from their national companies to Russia in the areas of advanced technology (including semiconductors and computer components) used in electronics, aerospace, oil exploration, telecommunications, and shipping.

The response by the U.S., U.K., the EU and others to impose a coordinated set of sanctions on Russia’s banking sector has, to date, been remarkably aggressive, and executed over a short period of time.

The initial approach also concentrated on imposing sanctions—largely prohibitions on access to engaging in foreign currency-dominated transactions or a freeze on assets in those countries’ financial markets—on some of Russia’s largest banks, including Sberbank, VTB Bank and Promsvyazbank. While those actions will surely be punitive, they are a poor substitute for imposing blanket prohibitions on the Kremlin’s ability to weather the scale of a systemic financial squeeze required to freeze out the Russian economy from participating in global markets.

To this end the U.S., U.K., EU and Canada are introducing measures that will not only restrict Russia’s central bank from accessing two-thirds of the nation’s foreign financial reserves, which Moscow was eyeing to soften the pain of sanctions, including limiting a downdraft in the ruble’s value, but also ban Russian commercial banks from accessing SWIFT (the Society for Worldwide Interbank Financial Telecommunication), the global electronic messaging system used to communicate orders and receipts of cross-border inter-bank resource flows.

While the imposition of such financial sanctions on a country is not unprecedented, the degree to which they are fairly systemic (though still not comprehensive and not uniformly applied by the West) is extraordinary.

Policy Changes in Global Oil Supply and Demand as Sanctions? Given the important role played by oil revenues in keeping Russia’s economy functioning, how international oil suppliers and customers behave with respect to doing business with Russian entities will have direct effects on the size of Mr. Putin’s war chest and thus his ability to keep the economic engine running.

It is likely to be the case that if the financial sanctions imposed by the U.S. and its allies on Russia’s banks and other institutions that mediate Russia’s international oil transactions are comprehensive and effectively enforced with no leakage or barter—perhaps a tall order—they could well hinder, if not, freeze Russian oil firms’ abilities to export oil.

There may also be situations that, like in other industrial and services sectors—from automobile producers to electronics and advanced technology companies to logistics and shipping firms—where foreign corporates unilaterally boycott doing business with Russia owing to reputational risk, international oil traders and other firms may well simply boycott purchasing Russian-produced oil.

Since globally, oil is priced and paid for in dollars, bypassing Russia will deprive Mr. Putin, his central bank and other Russian banks from building up their dollar reserves. In both cases, however, if such behavior is across the board by the U.S. and its allies, it will have the effect of reducing the supply of oil in world markets and thereby raise the global price of oil, which already have risen significantly since the outbreak of hostilities.

Critically, a further hike in oil prices would unlikely result if it was only the U.S. that stopped buying Russian oil. Why? Because at present U.S. oil imports from Russia account for only just under 8 percent of total U.S. oil imports. Such an amount could be filled by either other large oil producers increasing their sales to the U.S. (e.g., Canada, Mexico or Saudi Arabia) or the U.S. releasing oil from the Strategic Petroleum Reserve.)

An alternative strategy—that is, aside from placing sanctions on Russian financial institutions mediating oil transactions or unilateral boycotts—would be for the U.S., Canada, U.K., E.U., and Japan, for example, to impose sanctions directly on all transactions of Russian oil regardless of how they are financed (including, presumably, the use of barter). Collectively coordinated, that also will increase world oil prices.

Of course, a hike in the price of oil will raise energy costs throughout the world economy and stunt global growth. However, how increased oil prices shake out in terms of the magnitude of oil revenues moving through the Russian economy is not clear-cut. But one thing is for certain: all other things equal, the oil Russia does sell would fetch higher prices.

So what, then, would be a sure-fire method to utilize oil as a vehicle to weaken the foundation of the Russian economy? Flooding the world oil market with additional output to drive down oil prices. This would seem to be a no-brainer sanction to be put on the table. In theory, at least.

The rub is that at present, spare production capacity among oil producing countries has already become tighter than usual to restrain prices from rising further than they have in recent weeks: since December, the per barrel price of oil has jumped significantly from the mid-$60s to above $100.

Currently, Saudi Arabia, the world’s largest oil exporter, has the greatest amount of spare production capacity available—close to 2 million barrels a day. Should Washington, London, Brussels, and Ottawa be able to persuade Riyadh to expand output, that would surely drive down oil prices.

But it is unlikely—given the overall size of the global oil market and the additional volume of oil the Saudi’s (currently) could produce—that prices would fall dramatically enough—and remain at a level—to inflict significant harm on Russia’s oil revenues. To do that, coordinated releases would be needed from oil consuming countries’ stockpiles, such as the U.S. Strategic Petroleum Reserve (SPR). And such coordinated drawdowns would need to be both substantial (relative to the current volume of oil in the global market) and sustained.

The goal is to not only increase supply sizably relative to demand, but also send a credible signal to the overall oil market that the supply-demand balance has structurally shifted. Failing to do both will unlikely have the desired impact on oil prices. A unsatisfactory outcome would be one where an enlargement of supplies fails to move prices lower. In fact, if such a strategy does backfire, it may well result in oil prices to increase since oil buyers and sellers could lose confidence in the stability and integrity of the market.

Regrettably, the core issue remains this: while conceptually flooding the supply of global oil markets to reduce oil prices could be the most effective approach to penalize Russia, the reality is that current world oil stocks are unlikely to be large enough for this to work. But shutting off demand for Russian oil, such as in proposals being discussed, will surely not work.

Equally important, even if coordinated drawdowns are done adroitly and do significantly lower world oil prices and thus adversely affect Russia, they may also engender new risks to oil consuming countries on the domestic front, namely:

Cause and Effect

The current round of sanctions imposed on Russia are surely meaningful. It would be hard to believe—should they remain in place for a considered period of time and enforced—if they do not exact (potentially) serious economic hardship on Russia’s citizenry.

The critical issue, however, is that in light of Putin’s full iron grip on Russia whether any resulting pressure from below will actually lead to the changes in his policy and conduct that the rest of the world is seeking from the use of sanctions.

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