Myths and Realities of Sanctions in Russia

A lack of public anger

Myth No.1: Sanctions against Russia are not having the desired effect.

Russian television and popular culture has lately been presenting the West as some sort of collective bumbling despot.  Assorted political talking heads contend that Western sanctions were a horrible mistake and have proved useless or even counterproductive as Russian citizens have only rallied around the ruling elite. This is the rationale of appeals to end or ease the sanctions, not only by members of the opposition but also by government officials and government-sponsored media.

It is far from obvious what effects the Ukraine-related sanctions are having on Russia. Recent history has few clear-cut sanctions success stories, even with international embargoes approved by the UN Security Council. In Yugoslavia, South Africa, North Korea or Cuba there is little evidence that sanctions had a strong effect. Yet the cases of Sierra Leone, Liberia, Libya, and perhaps also Iran, suggest that sanctions can be also quite effective. And this is before we mention that they are much better than the alternative of military action.

Yet the Western notion that sanctions will drive the population to overthrow a ruling regime and change course is unrealistic. History has shown that autocratic governments find it quite easy to blame foreign powers for the real and imagined hardships of the general population, which usually suffers the most from sanctions. This pressure allows regimes not only to consolidate their political base, but to earn a “mobilization bonus” such as the Kremlin’s current 85 percent level of support.

The architects of modern-day sanctions understand these issues very well and nowadays attempt a new approach: targeted sanctions against specific members of the elite. We are now seeing these “smart sanctions” in action against Russia. The growing discontent inside the Russian elite shows that this attempt is having some effect. There is more to this than the fact that some members of the Russian ruling class are being forced to schedule routine medical operations in Israel rather than in Germany, or the seizure of bank accounts and real estate assets that are fairly unimportant for their owners.

It would be naïve for the West to expect the rapid elimination of the root cause of the sanctions—a restoration of the Russian-Ukrainian border of mid-February 2014. Yet no one ever believed this was the real goal. The aim of the sanctions was to send a clear signal of the West’s political position and, more importantly, to try to prevent a further escalation of the conflict.

The sanctions are dynamic, not static. They can be strengthened or eased in order to restrain or stimulate certain actions. We do not know how far military activity in Ukraine would have gone otherwise, since the ceasefires and agreements negotiated in Minsk were largely the result of the sanctions. In the light of all this, it is no longer correct to say that the sanctions have had no effect.

Costs and benefits

Myth No.2 is being disseminated for those who are too well-informed or too skeptical to buy into Myth No.1. This is the idea that sanctions are proving too harmful to Western business and will therefore soon be repealed.

Do sanctions hurt the side that imposes them? Absolutely. Economic models on the effects of sanctions clearly show that a deliberate disruption of the optimal balance in international trade causes losses for both the targets and the initiators of sanctions.

How much do the latter sacrifice? A new study published by the Austrian Institute of Economic Research (WIFO) estimates that the Ukraine-related sanctions and counter-sanctions could cost the economy of the European Union up to 100 billion euros and two million jobs. The authors do not disclose their research methodology, but their figures appear to be greatly inflated. First of all, all of Europe’s overall losses from the Russian economic crisis are being lumped into this figure, although many of them are unrelated to the sanctions. Mercedes sales, for example, are clearly falling for other reasons. Secondly, the luxurious repertoire of European food on offer in Moscow restaurants suggests that many of Russia’s counter-sanctions are not actually working and are therefore doing little harm to European agricultural producers.

Still, let’s consider the hypothetical possibility that Europe really will suffer 100 billion euros in losses. That would be very bad news indeed, but it would be especially bad news for Russia. That is because it seems that Western politicians have concluded that the considerable losses they suffer from sanctions are still lower than the moral and political victory of keeping them in place.

So, the higher the value that Russia attaches to Europeans’ economic losses, the greater the threat that the EU feels from Russia and the greater the importance it attributes to sanctions as a means of containing this threat. The most realistic path towards ending the sanctions will not come from the Foreign Ministry’s tactic of playing on supposed disagreements within the Western coalition. Instead of trying to exaggerate the losses that sanctions have brought to others, the Russian leadership should think about how to lessen the moral and political advantage that the West derives from keeping the sanctions in place.

Relative losses

Myth No.3 maintains that sanctions have a negligible effect on Russia. Myth No.3 and Myth No.2—that the West suffers great losses from these same sanctions—are strange bedfellows. Theoretical international trade models suggest that the losses of the targets and initiators of sanctions should be symmetrical.

Let us suppose again that the Austrian experts are correct and that sanctions with Russia could cost the economy of the European Union up to 100 billion euros. This enormous figure is still far below one percent of the EU’s GDP. Moreover, the EU is not the only actor to have imposed sanctions on Russia. Russia’s economy accounts for a fraction of the combined economies of the coalition that it is up against. Assuming parity of losses, Russia is down no less than that same 100 billion euros, which is about eight percent of its GDP. Losses of this magnitude are not negligible.

Trade is only part of the problem. The effect of technological and financial sanctions is much more severe. Despite all the hype around the supposed success of import substitution, Russia is acutely vulnerable to curbs on technology transfers in the energy and defense sectors.

Sanctions are also asymmetrical in the financial market. Russia’s private sector is chronically dependent on foreign capital and suffers much more from the sanctions than do the purveyors of the capital, for whom Russia is only one of several medium-sized competing clients. Major Russian banks and corporations have already learned from visits to Asian financial centers that there is basically no alternative to Western capital markets.

This means that either Europe’s losses from sanctions and counter-sanctions are greatly exaggerated, or Russia’s own losses are much greater than perceived by the adherents of Myth No.3. Unfortunately, while the former is partially true, the latter is more likely and more harmful for Russia.

Sanctions revenues

Myth No.4 is being propagated to lessen the pain. This is the idea that Russia’s economy has got used to sanctions and hardly notices them.

There are a myriad of reports in the Russian media asserting that the country’s economy is doing much better than expected under sanctions. And it is true that Russians have found numerous ways to get round the restrictions.

Any limits and prohibitions on economic activity always create opportunities to generate new revenues. Today, the average law firm is just as good at taking advantage of these situations as the smugglers and bootleggers of yore. However, there are two reasons to not be too enthusiastic about these adaptations. First of all, fake “Belarusian salmon” is bound to be more expensive than real Norwegian salmon. Any means of dodging sanctions bears the additional costs of “contraband lawyers”, as well as risks, as, for example, when Russian borrowers package debt as consecutive 30-day tranches in order to sidestep restrictions on long-term financing. Naturally, none of this reduces the expenses of domestic consumers and business, nor does it bolster the competitive position of the Russian economy.

Secondly, there is a growing appetite for the extension of Russia’s counter-sanctions which suggests that certain lobbyists have concluded that they are an excellent means of earning new revenues and that it will be difficult to roll them back.

Import substitution

The last, strangest and perhaps most pervasive myth is Myth No.5, which maintains that sanctions are helping rather than hindering Russia’s economic development. This may be the most authentic myth, since it most completely defies logic. What possible benefits could the Russian economy gain from sanctions?

In theory, if domestic producers don’t have to worry about competition in certain sectors, they can capture those sectors. This, in effect, is import substitution. However, there is a big gap between theory and practice. Creating new businesses in Russia from scratch requires investment, and therefore cheap sources of lending which are currently in short supply, in part due to sanctions. Even the most basic increase in production requires, in addition to working capital, surplus capacity, labor, and high-quality raw materials. There are few sectors of the economy which can provide these.

Furthermore, investment in import substitution only makes sense if there is a guarantee that vacant niches remain open for a long time and that there is no overall economic turbulence. That is not the case in Russia at the moment. The government has the reputation of changing its economic policy at short notice for political reasons—counter-sanctions could be repealed at a moment’s notice. Moreover, the economy is entering a recession, and domestic demand is falling. Businessmen are unlikely to view this as an auspicious time for import substitution.

There is also talk of the benefit of diversification resulting from a “pivot to the East”, a re-orientation of the Russian economy to Asian markets. However, the advantages of this are almost certainly exaggerated. Asia has its own business culture and challenges, and diversification can only work when there is free choice among multiple alternatives. When the options are already limited, it is not proper diversification.

Lengthy, costly and futile

There is one more hazy but grand rationalization of the current situation: that “Whenever the going gets really tough we Russians mobilize ourselves and work wonders”. We will not even try to argue with such an incoherent thesis. If we do not resort to this kind of logic, there are no visible benefits from sanctions to Russia’s economy.
This short overview in sanctions mythology can be summarized as follows:

Lesson One: Sanctions are here for the long term—even if one imagines what is now unthinkable, an abrupt change in Russia’s political course. Legal, political, and psychological factors have given the sanctions process a certain inertia and pushed it past the point of no return both in Russia and in the West.

Lesson Two: The damage suffered by the Russian economy from sanctions and counter-sanctions greatly exceeds that which Western countries are facing. The Russian government’s attempts to match and outdo its adversaries are only exacerbating the country’s losses.

Lesson Three: Russia can survive the effects of sanctions for a long time and in relative comfort, but there can be no healthy development in these conditions.

Oleg Buklemishev is Director of the Economic Policy Research Center, Moscow State University

This text is based on two articles originally published in Russian on Carnegie.ru.