Sanctions against Russia will work, but slowly — L’Indro

In response to the Russian invasion of Ukraine, the G7 and some 50 other countries have imposed economic sanctions on Russia. They are divided into two broad categories: real and financial. The real sanctions include restrictions on trade with Russia and the revocation of its most favored nation status. The financial ones involve the freezing of Russian assets held abroad and measures that prevent the settlement of cross-border funds.

While not part of the sanctions per se, the withdrawal of Western companies from Russia triggered by the sanctions has had a real impact. There have also been significant outflows of skilled human capital in Russia, partly due to the gloomy economic outlook under sanctions.

Since economic welfare depends on real variables such as consumption and employment, real sanctions have a tangible effect on Russia. But since any trade, domestic or international, benefits both seller and buyer, trade restrictions are a double-edged sword that also harms the well-being of sanctioners. This tends to moderate and slow down the latter’s actions. The refusal of some countries to trade with Russia also creates opportunities for others to trade on favorable terms. Such opportunistic behavior has given Russia a breather.

As for financial sanctions, Asset freeze hits wealth of Russia’s top officials and oligarchs, as well as Russia’s central bank’s foreign reserves. Since this incurs minimal cost to sanctioners and clearly harms sanctioners, it is easy to introduce. Yet its impact on Russia’s domestic economy is minimal.

Russia’s fund settlement sanctions exclude Russian banks from the Society for Global Interbank Financial Telecommunication (SWIFT) network and prohibit them from accessing hard currency settlement. They would be effective if they hindered real economic activities, especially trade. However, there are many loopholes.

L’exclusion from SWIFT it was initially touted as a “financial nuclear weapon”: this was a grossly exaggerated assessment. SWIFT is just a messaging application that is commonly used in international fund transfers. Although the exclusion from it certainly causes inconvenience, there are other means of communication for sending cross-border funds transfer instructions.

Penalties prohibiting access to settlements in major financial centers can be circumvented. For example, if Russia’s trading partners accept payments in renminbi, which Chinese exporters and importers will surely do, Russia can continue to trade.

The goal of the sanctions was to damage the Russian economy enough to make it difficult for military operations to continue. Clear economic damage has been done: Russia’s GDP in 2022 is expected to shrink by 3.4%. But the extent of the damage turned out to be much less than initially hoped. President Vladimir Putin’s approval rating continues to be very high demonstrating that the sanctions have not impacted the public strongly enough to shake their support.

This does not mean that sanctions have failed. Conversely, they are likely to play a more critical role in the future.

Based on the principle that ‘changing the status quo by force’ is not acceptable, the only satisfactory conclusion of the conflict is for Ukraine to reconquer all the territories conquered by Russia. If the war ends like this, it’s a complete loss for Russia.

While this is desirable from a global justice standpoint, Putin and his hardline supporters are unlikely to allow it, especially now that Russia has officially annexed the Ukrainian territories it occupies. There is a serious risk that, faced with a complete defeat, Russia may cross a red line in terms of the use of weapons and military tactics, which could escalate the conflict into a world war. To avert this Armageddon scenario, the global community must find a way to stop the war before Russia loses completely, even if that means forcing Ukraine to compromise.

It is important to distinguish between the truce thus achieved and the end of the war. Under a truce, the West can and should continue the sanctions. While their short-term effect has been smaller than initial expectations, there is no doubt that the sanctions will have a debilitating impact on the Russian economy in the medium to long term. With the withdrawal of Western companies, Russia’s industrial technology has experienced a substantial decline. Valuable human capital has left and will continue to leave the country, weakening its growth potential.

When this sobering reality becomes clear, Russians may realize there is no future for them unless they have a political leader who can come to terms with the West. This could lead to regime change in Russia and provide an opportunity to negotiate an end to the war consistent with global justice.

An important caveat to this strategy is the way Russia’s allies and neutrals behave during a truce. If they continue to support Russia voluntarily or opportunistically, regime change will not happen. Just look at the example of North Korea, where a highly autocratic regime has long survived in the face of international sanctions, largely due to China’s acceptance of its reign.

To avoid creating a Russian “Greater North Korea”, it is essential that the West continues diplomatic efforts to mobilize the support of neutral countries and, if possible, convert Russia’s allies to the side that opposes military solutions of international disputes.

Sanctions against Russia will work, but slowly — L’Indro