How Will Sanctions Affect Russia?

Summary

• A long history of economic sanctions can teach us what to expect from the penalties imposed on Russian firms and oligarchs.
• The most applicable evidence is from Iran. It shows export sanctions are largely ineffective, especially for large firms with existing business relations in non-sanctioning countries. 
• Meanwhile, financial sanctions are much more effective at targeting politically linked firms, while minimizing collateral damage.
• However, if the Kremlin bails out strategic firms, like after the 2014 annexation of Crimea, taxpayers could foot up to 50% of the overall cost of sanctions. This risks alienating Russia’s population in the long run and could hinder any political regime change.

Introduction

Russia is now enduring over 6,000 sanctions, making it the most sanctioned country in the world. The penalties cover oligarchs, exporters, politicians and banks. We summarise them in our latest tracker. Western countries hope the Ukraine conflict is not worth the price Russia will endure from these sanctions. But how significant could the economic fallout be?

We combine the results from several papers by researchers at Harvard University and the Fed on the effect of a ‘new generation’ of sanctions on Iran. We also reveal lessons from the sanctions against Russia after the 2014 annexation of Crimea.

A New Generation of Sanctions

Economic sanctions date to antiquity. Athenian statesman Pericles levied sanctions against nearby Megara in 432 B.C. These were akin to a modern-day trade embargo, and many of the sanctions the world has imposed since relate to trade. These ‘first-generation’ sanctions excluded a target country from access to markets (often physically via blockades) and commonly involved severe collateral damage.

Consequently, most pre-2000s academic literature suggest economic sanctions are relatively ineffective (Appendix). The conventional wisdom was that the more severe the economic measures, the more likely the sanctions will succeed. But that hurt populations and often solidified a targeted leader’s resistance. Sanctions saw infrequent use in the 20^th century (Chart 1). The reason is probably a balance of this ineffectiveness and the effective military dissuasion that the often significantly larger sanctioning countries afforded.

Source: van Bergeijk (2021), VOXEU

Times have changed, though, especially regarding Russia. Its nuclear capabilities mean economic sanctions have become the preferred diplomatic tool. We are witnessing a ‘new generation’ of targeted and covert sanctions intended to increase the economic cost to the sanctioned and reduce the cost to the sanctioners. The US has led this shift, naming over 6,500 targets across 60 distinct sanctions programs against at least 19 countries as of November 2020.

This new type of sanction usually targets individual firms, sectors, politicians and/or other influential individuals. The causal impacts are therefore harder to tease out and require more micro-level data. This data is typically harder to access in sanctioned countries. Nevertheless, recent years give two good case studies – Iran and Russia.

Iranian Sanctions 2008-2016

Export Sanctions

I start with a paper by Harvard University researcher Jamal Haidar. He looks at 1.8mn non-oil export transactions from 2006-2011 to see how US, EU, Canadian and Australian sanctions affected Iran’s non-oil exports. The sanctions were typical in structure, helping us understand how exporters from other countries may behave in future.

The paper is unique for accessing highly disaggregated export data. It allows the author to see how firm-level exports changed from the moment sanctions were implemented. Haidar can then quantify the scale of export destruction (lost exports) and export deflection (exports redirected to non-sanctioning countries) caused by the sanctions. Their results are sevenfold.

First, two-thirds of the value of Iranian exports destroyed by sanctions were deflected to non-sanctioning countries (NSC) (Chart 2). Second, those Iranian entities who already exported to NSCs significantly increased exports. Third, the products most easily deflected were core and homogenous products (e.g., commodities). Fourth, larger exporters were more capable of switching destination countries.

Source: Paper, page 332

Fifth, exporters typically had to reduce their prices and increase their quantities to saturate new markets. This led to an overall welfare loss for exporting firms. Sixth, new export destinations were more politically sympathetic to Iran. Finally, the probability that an export would deflect rose if the exporter already existed in that destination country.

The results show exporting (non-oil) firms could redirect exports to politically friendly destinations. Also, they show firms already exporting to those destinations increased exports. Total exports therefore increased due to sanctions. They did, however, cause short-term inconvenience and lowered firm welfare as Iranian firms had to lower prices in foreign markets.

Financial Sanctions

For the impact of financial sanctions, I use a paper co-authored by a Fed researcher. They study Iranian corporations listed in the Tehran Stock Exchange that faced sanctions between 2011 and 2016. At the height of sanctions, this was around 90 companies.

The authors find financial sanctions against a firm or industry caused significant short-term and long-term abnormal negative returns. These sanctions affected politically connected firms more than ordinary ones. And they have lasting negative effects on profitability ratios. Firms targeted by financial sanctions decreased their leverage and increased their cash holdings to manage their increased perceived risk.

Meanwhile, in cases of multiple sanction rounds, the marginal effectiveness of sanctions tends to decrease with each subsequent round. Also, multilateral sanctions are no more successful than unilateral ones, which is interesting given the scale of sanctions recently imposed on Russia. Lastly, when sanctions are lifted, the authors find politically connected firms’ stock prices bounce back more slowly.

Overall, the paper implies that targeted financial sanctions work. Companies with deep-state connections suffered heavier costs than their peers without such links. So given sufficiently severe targeted sanctions, it is possible to exert enough pressure to change the target’s behaviour.

Russian Sanctions, 2014 Onwards

The final paper is from the European Economic Review. It studies the impact of targeted sanctions on 3,000 firms and individuals after Russia annexed Crimea in 2014. Individuals can either be business or political figures. They just need to be on the EU and US sanctions list from 17 March 2014 to 1 December 2016.

On average, the authors find a sanctioned Russian company lost roughly 25% of its operating revenue, over 50% of its asset value, and about 33% of its employees versus a non-targeted peer company. The larger the dependence of targeted firms on Western services, the larger the impact. This tends to mean firms more reliant on imported services.

The costs of sanctions continue. The Kremlin designated some firms as ‘strategic’, and evidence suggests it shielded these firms from economic sanctions. The cost of bailing these strategic firms out was around 45% of the overall cost of sanctions to the country. While this harmed the government, it also affected the average taxpayer, showing even targeted sanctions still cause collateral damage.

This is also true for non-targeted firms. The authors find minority-owned subsidiaries of sanctioned companies suffer similar losses to majority-owned subsidiaries. The share of targeted firms in a sector has a small, negative impact on the performance of non-targeted firms in the same sector.

Bottom Line

What impacts will Russian sanctions have? The literature suggests large short- to medium-term consequences, especially from financial sanctions. However, the long-term effects are less certain. There will be welfare scarring, where politically connected firms take longer to bounce back. But inevitably, exporters, at least non-oil ones, will pivot towards non-sanctioning countries over time. So trade should recover.

Will the sanctions induce a political change? Here the West must be careful. The breadth of sanctions will lead to economic hardship for Russia’s population. This will test Russians’ resolve, which history tells us often drives greater support for its leaders. So, if sanctions alienate Russia’s population in the long run, it may undermine permanent structural changes.

Appendix

Common Reasons Why Sanctions Fail

US economist Gary Hufbauer is a prominent researcher in the field. His 2009 book, Economic Sanctions Reconsidered, offers a good review of why sanctions may not work. He mentions four reasons why economic sanctions fail.

1. Sanctions are inadequate for the task. The goals may be too elusive and/or the means are too gentle.
2. Sanctions may create their own antidotes. They may unify the target country both in support of its government and in search of commercial alternatives.
3. Sanctions may prompt support from powerful or wealthy allies of the target country that offset the sanctions themselves.
4. Sanctions may alienate allies abroad and business interests at home. If allies do not support the sanctions’ goals, it will undermine their intended outcomes.

Meanwhile, sanctions are more likely to work when the target is under extreme duress; a prior friendly relationship between the sender and target existed (i.e., they were allies); there is little assistance from third parties to counteract the sanctions; there are closer trading relationships between the sender and target; sanctions affect the targets national security interests; international organisations act as a mediator in coordinating sanctions.