The cost of EU sanctions against Russia

European leaders were shocked when they learnt that the combined GDP (gross domestic product) of the euro zone-the eighteen countries that use the euro-had not changed at all from that of the previous quarter. It happened, when they were expecting growth. It had not taken long for discussion to begin about what it meant for Europe. Unsurprisingly, Russia came up.
The European Union (EU) adopted new sanctions against Russia over its alleged involvement in the conflict in Ukraine. But the EU delayed enforcing them to get time to assess whether a ceasefire in Ukraine was holding. German exports to Russia saw a 15 per cent fall and a damage bill ranged up to five billion euros for the EU farmers. Those were just some of the costs of the row with Russia. The row led to sanctions heading both east and west. As is usual for the EU, the selection and assessment of options considered for economic sanctions are done based on some criteria like effectiveness, cost and benefit, balance across sectors and member states, international coordination, reversibility and scalability, legal defensibility and ease of enforcement. The EU has pledged to compensate some sanctioned European sectors. Russia has also promised its targeted businesses the same support.
The sanctions would certainly ratchet up pressure on Moscow. As is seen in the graph below, the EU is by far Russia's biggest trading partner. Imports of the EU from Russia are dominated by crude oil and gas. According to the Energy Information Administration, European countries import 84 per cent of Russia's oil exports and about 76 per cent of its natural gas. Germany is the single biggest importer of Russian oil and gas while the UK buys about 6.0 per cent of Russia's gas.
It was not long ago when Kremlin officials could hardly avoid laughing when asked about the economic sanctions imposed on Russia by the West. As long as every NATO member state jealously sought to protect its own business interests, things "weren't all that bad," they gloated. But recently their moods darkened. For months, the European Union in particular had been reluctant to enact effective penalties against Moscow. Though the 28 EU heads of state and government cleared a psychological hurdle, for the first time they opted to go beyond sanctions targeting individual political leaders in Moscow, prohibiting business with specific Russian companies that contribute to destabilisation of the situation in Ukraine. European development banks have also been banned from providing loans to Russian companies.
The US, for its part, penalised a dozen leading Russian conglomerates, including oil giant Rosneft, natural gas producer Novatek, Gazprombank and the weapons manufacturer Kalashnikov. From now on, they are forbidden from borrowing money from American monetary institutions and from issuing medium- and long-term debts to investors with ties to the US.
For the companies involved, the penalties are a significant blow. It has become difficult to acquire capital in Russia itself, with both domestic and foreign investors withdrawing their money from the country in recent months. It is hardly surprising to note that Russian Prime Minister Dmitry Medvedev spoke of a return to the Cold War and President Vladimir Putin warned that sanctions "usually have a boomerang effect."
Even prior to the sanctions, the Russian economy had been struggling. Now the Ukraine crisis is beginning to make itself felt in Germany as well. German Committee on Eastern European Economic Relations believes that the crisis could endanger up to 25,000 jobs in the country. In the event of a broad recession befalling Russia, the German growth also could sink by 0.5 per cent, according to a Deutsche Bank study. Banking, for example, is a two-way process. Nina Schick of Open Europe estimates that Russian companies have foreign debts to the tune of $ 653 billion. Any financial shock in Russia will impact on the banking systems in Europe and the US. Targeting Russian energy companies also has its consequences, especially for Europe.
It's certainly complicated, and not without negative implications for Western governments. Some further sanctions would require agreements from EU member states. As the consequences of tougher sanctions might hit countries differently, getting that approval could be a protracted process. At this moment there appears to be strong political support in the US and Europe for action that is more than just symbolic.
The most recent US sanctions, warns Eckhard Cordes, head of the Berlin-based Committee on Eastern European Economic Relations, have placed an additional strain "on the general investment climate." Particularly because, European companies have to conform to the American penalties.
Stefan Fittkau, who heads the Moscow office of Eagle Burgmann, the Bavaria-based industrial sealing specialists, says company sales have already plunged by 30 per cent. "Orders have been cancelled or delayed -- or we simply don't receive them anymore," he says. Novatek, Russia's second largest natural gas company, for example, had hired Eagle Burgmann to take care of seals at a vast liquefied natural gas facility on the Yamal Peninsula in Siberia. Now business with Novatek is no longer allowed.
The inclusion of Rosneft on the list also affects more than a dozen German companies: The construction firm Bilfinger maintains facilities for Rosneft, for example, while Siemens received a €90 million contract to supply turbines and generators. In the end, both sides-the Russians and the Europeans-will lose.
The Russians imposed a ban on €12 billion worth of imports. The damage to the exporters appears to be €125 million. The damage to Russian consumers is at least that full amount of €12 billion.
A key problem all along has been that though sanctions serve a common purpose, the costs of implementing them are borne by individual member states. Moreover, the costs are very concrete and visible, as jobs in enterprises that depend on exports to Russia seem to be at stake. So it is not surprising that many member states are more concerned about the potential cost of the sanctions on their economies than they are about the overall foreign-policy goal of signaling to Russia that its disregard of international law and norms has consequences.
That is why a common fund to provide compensation for the economic costs of sanctions should be an integral part of the EU's emerging foreign policy stance toward Russia. Creating such a fund would provide a potent symbol of solidarity within the EU, while providing an ideal opportunity to reflect on the nature of the sanctions' costs.
From an economist's perspective, a key point is that losing export sales does not represent a cost per se. For example, if a company that produces a generic consumer product, such as food, or even cars, sells less in Russia than it did before, one should not necessarily count the reduction as a loss. After all, if such goods have a global market, a loss of sales in one market can be compensated by higher sales in another.
In fact, a large proportion of Russian imports from the EU are precisely of these generic consumer goods, which are not affected by sanctions. Thus, reports claiming that sanctions imply a high cost-because EU exports to Russia amounted to €120 billion ($161 billion) last year and account for tens of thousands of jobs-are highly misleading.
An economic loss arises, only if a firm produces some specialised goods that can be sold only in Russia using labour and capital that are also specialised and cannot be employed to produce something else. This applies especially to Germany: the famous German Mittelstand often produces highly specialised goods; but it also prides itself on its flexibility and adaptability. Given this, there might be a case for compensation in some cases, but it should be strictly limited to the time.
It would not be difficult to develop objective criteria for access to an EU "Sanctions Compensation Fund". A firm could be eligible for compensation, if it operated in the sectors covered by sanctions, and if the product in question had special characteristics that prevented sales from being redirected elsewhere.
But there are two sectors which need no compensation: energy and finance. Why? The risk to Europe's energy imports from Russia is negligible. Should Russia demand a higher price for its oil, Europe could simply turn to the global market. Likewise, Russian gas giant Gazprom could increase the price it charges its European customers only by breaking existing contracts. Moreover, Europe is the only customer for a large share of Russian gas exports, which, at least in the short run, must be transported through the existing pipelines.
Given this, the case for compensation in the energy sector is exceptionally weak. Only the makers of highly specialised equipment, perhaps for exploration under Siberian conditions, might have grounds for drawing on the compensation fund.
The case for compensation is even weaker in the European financial sector. Providing the kind of medium to long-term financing that is now subject to sanctions constitutes an infinitesimal fraction of European banks' business. Moreover, as Russia's political system becomes ever more oppressive, and its legal system ever more arbitrary, rich Russians will be more inclined than they already are to establish a safe base abroad for their wealth and families. The freedom and rule of law provided by financial centres, such as London, will become even more attractive.
In 2006, the EU established a "Globalisation Adjustment Fund" to cushion those sectors hardest hit by rising imports. Though initially only €500 million was allocated for it, a rather modest sum compared to the overall annual EU budget of around €100 billion, its creation was an important signal of the EU's readiness to compensate those who lose out because of a common policy.
A similar political signal is needed today to overcome the EU member states' resistance to decisions that advance a common foreign policy. Here, too, the sum needed would probably be rather small compared to the overall EU budget.
The writer is Senior Assistant Secretary (Research & Development) of Bangladesh Knitwear Manufacturers & Exporters Association (BKMEA). [email protected]