People walking past a currency exchange rate board in Moscow on July 20.
-Analysis-
The world has never seen sanctions like those imposed against Russia in response to its invasion of Ukraine. There have been targeted sanctions, of course, or sanctions against rogue countries like North Korea with wide support from the international community. But never in history has there been such a large-scale sanctions regime against one of the world’s biggest and most important economies.
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As a result, debates around the effectiveness of sanctions and how best to use them to influence Russia continue to do the rounds.
Supporters of sanctions have a clear and unified message: we must stop Russia from being able to continue this war. We must deprive them of the goods and technologies necessary for the production of weapons and military equipment, and prevent Russians from living normal lives.
Opponents argue that the sanctions backfire. They insist that Russia is a large enough economy, highly integrated into the energy market and international supply chains, and therefore has enough resilience to withstand restrictions. Those who impose sanctions will be the ones to lose markets and suppliers. They will face increased energy prices and countless other problems. Russia will be able to replace lost relationships with new and even stronger ties with other states.
Economists at the Bank of Canada have attempted to resolve this debate and figure out who is hit hardest by sanctions. They pieced together a model featuring three parties: a country imposing sanctions, a country against which they were imposed, and a third independent country.
How to double cost to Moscow
In each country, the impact on households, financial sectors and production were modeled accounting for three types of sanctions: import and export sanctions (trade), financial sanctions, and embargoes on gas purchases. The researchers drew up various scenarios including individual and combined sanctions, sometimes supported and sometimes not supported by the third country.
If sanctions were supported by all the world’s major economies, Russia’s losses would be twice as large.
Each of the three types of sanctions led to a decrease in GDP in the state against which sanctions were imposed. However, the economy of the country who imposed the sanctions also shrank, albeit less than the sanctioned country.
The size of the damage was influenced by the actions of the third country, the model showed.
If the third country supported the sanctions, the effectiveness of the sanctions increased dramatically: the country being sanctioned experienced substantially greater losses, while those of the country that imposed the sanctions decreased.
It was, rather predictably, more profitable for the third country if it were to avoid joining the sanctions regime.
If sanctions were imposed in all three areas (trade, financial and gas) at once — as was the case with Russia — then the GDP of the sanctioned country decreased by 4%. If a third country also complied with the sanctions regime, the loss grew to 9%.
At the same time, the GDP of the country imposing the sanctions decreased by 0.79% in the first case and by 0.77% when a third country supported them.
When the third country didn’t join the sanctions regime, it benefited from cooperation with the sanctioned party: its GDP grew by 0.38%. But if it supported sanctions, it suffered the same losses as the primary imposer of sanctions (0.77%).
If restrictions were imposed solely against imports, the model showed that 23% of the lost supplies were replaced by a third country that did not join the sanctions regime. Indeed, Russia has already succeeded in replacing 10%-25% of the goods subject to sanctions via third countries.
The model thus showed that the behavior of India, Turkey, the United Arab Emirates (UAE) and other countries is quite rational. If China’s actions can also be explained by geopolitics, then by cooperating with Russia it is minimizing its losses and hoping to benefit economically from the war in Ukraine.
If sanctions were supported by all the world’s major economies, Russia’s losses would be twice as large as they are now, and collateral damage in the West would be slightly less. Thus, the role of countries who have not joined the sanctions regime against Russia remains critical.
No economic rationale
The model confirmed what was intuitively clear, says Elina Rybakova: “It is unprofitable for third countries to support sanctions and far better for them to trade with Russia, selling products and services at a higher price and bypassing sanctions.”
Despite the apparent obviousness of the conclusions, the very appearance of such calculations is an important milestone, since it provides a tool for analyzing how sanctions work.
“There are no economic models for sanctions yet,” says Rybakova. “We were the first to do any empirical research, and there are still very few theoretical studies out there. As a result, sanctions are being introduced without any solid foundations.”
“Most sanctions would be strengthened by the participation of as many countries as possible and ensuring proper compliance,” said Craig Kennedy, an expert at the Davis Center for Russian and Eurasian Studies. “The more countries that participate, the more difficult it will be for Moscow to purchase supplies to wage its war against Ukraine.”
What should we do?
The most obvious solution is to convince countries to join the sanctions. “Turkey can be motivated as a NATO member and as a country that receives a lot of investment from Europe,” says Rybakova. “It is potentially possible to negotiate with India, highlighting how trade with America and Europe would offset the potential losses of no trade with Russia. But I can’t see a situation where we would come to an agreement with China and convince Beijing to comply with US and European sanctions.”
“The effectiveness of sanctions depends primarily on how they are monitored,” says Oleg Itskhoki, a professor at the University of California, Los Angeles. He believes this is a more important factor than the behavior of third countries, although the two issues are related. “If the United States and Europe are not engaged in enforcing sanctions, then we cannot expect third countries to participate,” he adds.
It is not countries that violate sanctions, but individual companies.
“We are not talking so much about third countries, but about specific companies involved in trade,” explains Itskhoki. “If firms think that there is no control and that trade with Russia can be carried out with impunity, then why would they comply with sanctions? Is China's cooperation needed to force Chinese companies to comply with sanctions? It is often not necessary so long as Chinese companies understand the consequences of non-compliance, provided, of course, that there are consequences… It is not countries that violate sanctions, but individual companies.”
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