WEST’S SANCTIONS AGAINST RUSSIA ARE FLAWED

When considering sanctions, we need to distinguish between their effectiveness and impact. Figures about economic negatives such as reduced trade, foreign investment, credit flows, technology transfer, GDP growth, incomes, and so on these measure impact. They do not, however, tell us how likely the sanctions are to cause Russia to change its behavior that is, how effective they will be.

To put it another way, impact tells us how much pain we can cause. Effectiveness depends also on how able and willing Russians are to endure the pain. To answer that question, we need to understand, first, the peculiarities of the Russian economy and past Russian experience with economic hardship, and second, Russians’ motivations for the behavior we want to change.

The motivation for sanctions is to impose hardship in order to change behavior. But the likelihood that this would apply to Russia is very weak.

The core of the Russian economy, the part inherited from the Soviet Union, is an economic structure that is highly robust to negative shocks. Much is made of the alleged weakness of today’s Russian economy. This notion that the Russian economy is somehow fragile is the backbone of the sanctions argument. But inefficiency which definitely does characterize Russia’s economy is not the same as fragility. The very features of the Russian economy that account for its inefficiency and lack of competitiveness in the global economy are also its strengths in terms of robustness to shocks.  

Although sanctions and the pain they cause may result in some shifts in Russia’s behavior with respect to Ukraine, the changes will affect only tactics and timing, not Putin’s overall strategic goals and resolve to achieve those goals.  

There is no doubt that the West can take actions that harm the Russian economy. The West can weaken Russian state finances and make Russian citizens poorer. Neither effect will cause Putin to back down. Putin is not going to be deterred from aggressive behavior by economic weakness, whether caused by the global economy, his own policy, or sanctions. Russia can weather all those. And even though the economy can become smaller and poorer, Russia will still have its financial independence and freedom of action.

But we ought also to ask, what happens to Russia in the longer term? There are several points to note. First, the direct effects of sanctions on Russia may be severe. Economic growth is likely to turn negative. Notice, however, that economic growth was already slowing before this confrontation began. Sanctions will only provide an excuse for a worsening economy and slow the search for reform. This would be worse for economic performance, but probably good for Putin politically.

Nonetheless, it is important to recognize that Russia will rebound after the confrontation, as it always does after a crisis. In general we can expect fast post-conflict growth. Indeed, the deeper the drop, the faster the rebound growth. What level of income Russia attains in the short term is a different matter. Depending on how long the confrontation lasts, it will take longer for Russia to regain its current prosperity level once the conflict is over.

Russia also has the potential to rapidly bring back foreign investors who may have been frightened away or deterred from entering Russia during the conflict. The great magnet is, as always, its resource sector. Examples from recent and more remote Russian history tell us that Russia’s natural wealth will always attract foreign investors, almost irrespective of how they were treated in the past.  

None of this, however, should cause us to ignore some very serious concerns about Russia’s future that this crisis raises. The real worry is that a prolonged confrontation with the West, even without direct conflict, will make the prospects for Russia’s evolution as a modern society more remote.

The tendency towards import substitution was already underway before the Ukraine crisis. Heavy sanctions by the West will accelerate the movement in this direction. Even more important, the sanctions may cause an especially damaging qualitative shift in the nature of import substitution. Previously, import substitution was a policy limited to core manufacturing sectors, the “old economy.” Russia’s so-called new economy was to a large extent allowed to continue its integration into and dependence on the global marketplace. Now the process of important substitution will reach beyond the manufacturing sector to sectors that were previously integrated with the modern economy, such as banking.  

These tendencies to import substitution in the relatively modern sectors will be especially costly. When modern foreign companies are ousted in favor of Russian ones, the loss is much bigger. Companies in Russia’s “new economy,” whether foreign-owned or Russian, were driven by the forces of international competition. Their replacements will be directly under Putin’s control. This is a general conclusion: more import substitution and more reliance on rent distribution to cover the excess cost of such activities mean that more of the economy will dominated by Putin’s rent management system.

Sanctions thus lead to greater control by Putin over the economy. They weaken the relatively independent and modern part of Russia’s economy. They also reinforce Putin’s political power. They rally the public around Putin. Indeed, it is hard to see how sanctions do anything but weaken the liberals as a political force in Russia. This means that our current approach of dealing with Russia by sanctions and isolation will not only fail to accomplish its immediate goal of stopping Putin in Ukraine, but it will also be counterproductive to the more important, long-term objective of Russia’s evolution as a normal, modern, globally integrated country. With the approach we now have, not only do we lose the battle. We make it harder to win the war.

Last but not least, new sanctions against Russia will trigger new sanctions against the EU which will jeopardize economic recovery. Putin already announced that car manufacturers (Mercedes, BMW, VW, Renault) etc. will not be able to export their cars to Russia and Russia may decide to cut off gas flows to Europe this winter. Russia's energy minister Alexander Novak warned high risk of disruptions to Russian gas supplies to Europe this winter. The 28-nation bloc depends on energy imports for more than 50 percent of its needs, and roughly 40 percent of those imports are supplied by Russia. A cut-off of Russian gas that travels via Ukraine would impact most several south eastern European countries as they are highly dependent on these supplies and do not have other pipeline connections.