The West vs. Russia: The Unintended Consequences of Targeted Sanctions

October 8, 2014 Topic: SanctionsForeign Policy Region: RussiaUnited States

The West vs. Russia: The Unintended Consequences of Targeted Sanctions

"Russia is too big to isolate completely...and partial isolation is likely to have unintended consequences that contradict U.S. and European intent in imposing sanctions."

Sophisticated Russian economic experts, such as former Deputy Prime Minister Alexei Kudrin, have opposing views. They argue that retaliatory measures like these would immediately cause greater losses to the Russian economy and to Russian consumers. However, they say, the best “retaliation” is a “pivot to Asia” and to other emerging economies. The goal of this pivot would be to increase Russia’s finance and trade ties with sovereign funds and public companies from Asian, Latin American, and Arab countries willing to expand their exposure to Russia. Work in this direction has already begun, though it will be difficult to replace the 80% of foreign direct investment in Russia that comes from countries imposing sanctions.

Russia also has some other options. First among them is economic retaliation against Ukraine, which Moscow is already doing as part of a wider effort to destabilize that country. Russia has halted trade of more than one-hundred agricultural commodities and industrial products. Moscow has also frozen oil and gas deals and started to look for substitutes for military equipment imported from Ukraine in the past. Russia could still do much more.

Ukraine is highly vulnerable because its financial outlook is tragic. Its budget deficit and external debt service require nearly $30 billion. Covering development and recapitalization and addressing structural imbalances in the economy will take almost $200 billion through 2018 due to long-term underinvestment, according to some expert views.[3] These gigantic amounts are simply unavailable to the European Union, Russia, and Ukraine, even if the United States had the political will to assist. But if nothing is done, the “black hole” of Ukraine’s economy in the center of Europe will drag down the country’s westward and eastward integration and will constitute a long-term economic threat to all. In order to overcome the crisis and the fractures in Europe, it is necessary to create a new platform for cooperation. Both the EU’s Eastern Partnership and Russia’s Eurasian economic integration require serious correction.

This may sound unrealistic in the current political environment, but there is no alternative. Moreover, saving Ukraine could actually be the best project to transform the “sanctions regime” back into a “cooperation regime,” something much healthier for the European and global economy. Of course, this will not be possible until governments on all sides—not only Russia—are prepared to adjust their policies.

Russia’s most serious economic weapon—restricting oil and gas deliveries to Europe—is a double-edged sword. There is no easily available buyer of this product in Asia because new pipelines or railway deliveries will take years to build. Likewise, export facilities for liquefied natural gas are also pretty scarce. At this point, nobody in his senses openly speaks in favor of cutting off gas supplies to Ukraine, which might take away up to one-quarter of Russia’s federal budget revenues directly or as collateral damage. Nevertheless, Russia could still do this if the conflict deteriorates enough to make the Kremlin’s alternatives look even worse. From this perspective, it can be very dangerous to put too much pressure on Russia.

So far, most Russian experts have expressed concern that the Russian Federation cannot respond to Western sanctions without exacerbating the economic damage caused by them. Any actions taken by Moscow to curtail economic and technological cooperation, and any restrictions imposed on Western businesses in Russia would entail immediate losses to the nation's citizens, domestic businesses, and government. Nevertheless, if Russia’s isolationists gain sufficient political influence, these experts may no longer have significant input into policy formulation.

Russia has not yet reached this point. In late May, President Putin used the St. Petersburg Economic Forum as a platform for direct dialogue with Western businesses. He clearly intimated that, so far, the Kremlin does not view an isolationist program as a serious option. Putin insisted that, even in the new environment, Russia intends to follow the motto of “partnership for global development.” Speaking of sanctions, he lamented that “inability to find compromises, unwillingness to take into account partners’ lawful interests, and blunt use of pressure only add to chaos and instability and create new risks for the international community’s continued development.”

As he spoke to established Western investors in Russia, Putin asked rhetorical questions. Why do “successful businesses have to suffer losses and relinquish to competitors this huge market and the positions they had built up?” Further, “Does anyone gain from disruptions to regular cooperation between Russia and the European Union? Does anyone gain from seeing our joint work come to a standstill on what are important issues for everyone such as nuclear safety, fighting terrorism, trans-border crime, and drug trafficking, and other priority issues? Is this supposed to make the world any more stable and predictable? Surely it is clear that in today’s interdependent world, economic sanctions used as an instrument of political pressure have a boomerang effect that ultimately has consequences for business and the economy of the countries that impose them.” These pronouncements were completely devoid of any pro-isolationist enthusiasm.

The primary effect of international sanctions is partial or complete isolation of the sanctioned nation. Russia is too big to isolate completely, however, and partial isolation is likely to have unintended consequences that contradict U.S. and European intent in imposing sanctions. Should the West strengthen isolationist forces in Russia and provide incentives for Russia's “pivot” away from the West toward China, Latin America, and Africa? This is up to Washington and Brussels.

Igor Yurgens is President of the Institute of Contemporary Development, President of the All-Russian Insurance Association, and Vice President of the Russian Union of Industrialists and Entrepreneurs, one of Russia’s largest trade associations. In addition, he serves on a Russian presidential council on human rights and as a professor at Moscow’s respected Higher School of Economics. He is a leading authority on Russia’s economy and its international economic relationships. He holds a doctorate in economics.

[1] In June, the Russian regions' movement on the Fitch scale was mixed.

[2] In June, S&P slammed lesser players in the Russian financial market; more than half of them (18 out of 32) saw a downward outlook revision.

[3]Kulik S., Spartak A., Vinokurov E., and Igor Yurgens, “Two Integration Projects in Europe: Dead End of Struggle,” INSOR, a summary of a report commissioned by the Civic Initiatives Committee, Moscow, June 2014

Image: Kremlin website