Will Sanctions Change Russia?

DI ANDREA SCOTTO

06/05/2022

After Putin’s decision to invade Ukraine, Western countries unified to fight against his choice. They didn’t (and couldn’t) reply with conventional weapons, so they decided to use financial ones. Whether sanctions are right or not it depends. It depends at first by what we define as “right” and secondly by what the purposes are. This article has the goal to discuss the characteristics that may make sanctions more effective for the purpose of the countries involved: the withdraw of Russian armies.After Putin’s decision to invade Ukraine, Western countries unified to fight against his choice. They didn’t (and couldn’t) reply with conventional weapons, so they decided to use financial ones. Whether sanctions are right or not it depends. It depends at first by what we define as “right” and secondly by what the purposes are. This article has the goal to discuss the characteristics that may make sanctions more effective for the purpose of the countries involved: the withdraw of Russian armies.

Russian strengths and weaknesses

Russia’s economic situation has made clear to Putin since the beginning of his political career: the importance of building up financial reserves during good times. During (In) 1998 and 1999, Russia’s international reserves were about $12 billion, Putting the lesson to practice, Russia built up its reserves to a peak of nearly $600 billion in 2008. According to a recent report by the Russian government, $300bn of its $630bn in reserves are now unusable. The majority of Russian factories and equipment are outdated and this constricts how much they can make. The Russian Federation ranked as one of the lowest productive countries on the OECD ranking of 2019. A recent push for modernisation has brought Russia to become the World’s 8th largest investor in R&D in 2021, with a total amount of $60.57 billion. (Leading countries by gross research and development (R&D) expenditure worldwide in 2021, Statista). But it should be noticed that an increasing share of Russian GDP has constantly being spent on the defense sector. Furthermore, this is not enough to close the gap left by the UK and the US. The quality of products from China doesn’t match the goods they were used to receive from Ukraine or the West. Ultimately this could lead to a breakdown in machinery and an added cost in production. It has to be noticed that the reduction in trade between the EU (and more in general the West) and Russia is not only due to sanctions but it is also caused by a rapid slowdown in growth of the Russian economy. It is difficult to disentangle these two phenomena to measure the different impact.


This time is different (?)

Extraordinary measures have been taken compared to the previous set of sanctions that followed Crimea’s annexation. Most notably, in 2014, gas was exempted from sanctions because numerous EU Member States depend heavily on Russian supplies. It’s still to be seen if this time EU countries will agree on blocking Russian gas supplies. B. Moll and other German economists have assessed that the loss on German GDP (the highest in the EU) would be about 3% per year, an important damage but less than what some politicians were talking about some weeks before, fearing a depression.

With regard to financial sanctions, EU subsidiaries of blacklisted Russian banks operating in at least seven Member States (including France, Germany, Austria and Cyprus) were exempt. These subsidiaries held over €20 billion of assets at the end of 2013. While the situation right now is that more than 100 individuals, entities and subsidiaries will ultimately be sanctioned. EU leaders have agreed sanctions on Moscow that target 70% of the Russian banking market, European Commission President Ursula von der Leyen said. The “iron heel” of this sanctions package are financial sanctions. While they are surely capable of inflicting damage on the public, they also have a more direct and immediate impact on ruling elites by limiting their access to foreign currency. The microeconomic model suggested by Kaempfer and Lowenberg (1992) explained that sanctions are most likely to be effective when they concentrate income losses on groups benefiting from the target government policies”. This is exactly what the EU has tried to do by targeting Russian Oligarchs freezing their assets abroad.


Are sanctions against Russia hurting the West?

According to the calculations made by Bond, Odendahl, and Rankin , the EU is a far more important trading partner for Russia than the other way round. Based on total trade (exports and imports), the EU is roughly five times more important to Russia than vice versa. The EU buys more than half of Russian exports, equivalent to almost 10 percent of Russia's economic output.


Asymmetric impacts: a divided EU?

Existing research concludes that the effects of sanctions and countersanctions are not distributed evenly across the EU. WIFO found geographical closeness to be highly correlated with the size of the effects at the national level: Baltic countries, Finland and eastern European countries will be affected more than the EU average of 0.3% of GDP in the short term and 0.8% in the long run. These countries are amongst those with the highest exposure to trade with Russia as a percentage of their GDP. In absolute values Germany, as the biggest exporter to Russia, is unsurprisingly likely to be the most affected. Regarding the financial sector, France is by far the most exposed country, with approximately US$44 billion in outstanding loans to Russia, followed by Italy (US$27 billion), Germany (US$17 billion), and the UK (US$15 billion). Another strongly impacted sector is the food industry. EU agri-food exports account for 7% of total EU exports of goods. About 9% of these agri-food exports go to Russia, which is the second most important destination for EU agricultural products. Asymmetric impacts among western countries may create political division. To prevent this from happening it would be interesting to evaluate the validity of a reimbursement a posteriori to the companies that carried the most weight.


What expectations can we have?

Beyond hoping that the conflict will end as soon as possible for humanitarian reasons, we should hope the same for the success of our sanctions. In fact, if such would need to last more to reach our goals, that is likely to mean that they aren’t the right tool. What we are seeing right now it’s exactly that President Putin is not changing his plan. Some might say that longer sanctions would increase the disutility experienced by the target (Brady 1987). Although historical evidence has shown that sanctions are less effective the longer they are in place (Miyagawa, 1992), some studies (Kampfer and Lowenberg) have shown how the appearance of ineffectuality might be illusory: sanctions that crate minimal economic hardship can still generate political change. Even if Putin is not showing any availability to retreat from Ukraine, we are seeing that inside Russia protests increase rapidly, with thousands of people willing to risk going to jail to express their opinion. Sanctions then are also a political tool. In this case they have intentionally being applied (at least as publicly declared) to obtain a change of policy from the opponent (to stop the War in Ukraine and to withdraw its troops). Will Putin’s popularity be impacted negatively? We can see from the graph that Putin’s popularity rose incredibly after the annexation of Crimea in 2014. This shows how much positively that event has been perceived by the Russian population. But has the Donbass (and even the Rest of Ukraine) culturally the same meaning for Russians as Crimea has?


Nevertheless, the key element to keep the power and a constant level of popularity, as historical evidence shows, is a good economic conjuncture. The same graph shows that just the pensions reform (raising the retirement age) has reduced Putin’s popularity as much as the Crimea’s annexation had increased it. Since we are not in physics and we can’t apply some law that has never been contradicted, we can think by analogy and look at what history tells. It tells that both in Syria in 2012-20 and in Myanmar in 2021, UN commissions accused the regimes of war crimes. Both countries were subjected to sanctions—and both regimes remain. Those are just two examples of how sanctions (and in case of Syria even some direct military involvement) are hardly successful in fighting tyrannical regimes. Think of Iran if that isn’t enough.

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