Why the Russian sanctions don\\\'t work

Anatole Kaletsky of Reuters | Published: May 04, 2014 00:00:00 | Updated: November 30, 2024 06:01:00

Why did the U.S. and European sanctions against Russia earlier this week trigger a rebound in the ruble and the Moscow stock market?
To understand this paradox it is worth recalling Yes Minister, the British TV comedy about a blundering politician who stumbles from crisis to crisis with the same justification for every panic response: "Something must be done. This is something -- therefore it must be done."
The problem with this syllogism is that doing something may be worse than doing nothing - and the Western decision to rely on economic sanctions in the Ukraine crisis is a case in point.
The obvious objection is that economic gestures from the United States and Europe have proved pathetically ineffectual in deterring Russia and only emphasises the West's lack of conviction and planning. Russian President Vladimir Putin, meanwhile, has achieved what were probably his main goals: gaining tacit international recognition for the annexation of Crimea, as an irreversible fait accompli; and extracting an admission from Ukrainian President Oleksandr Turchynov that Kiev is "helpless" to prevent the country's disintegration as long as Russia remains hostile.
In addition to conceding these huge gains to Putin and undermining U.S. credibility as a global policeman in the Middle East and Asia, economic sanctions could prove disastrous for several more subtle reasons.
First, the transformation of what was a military-diplomatic dispute about Ukraine's borders into an economic confrontation between the West and Russia is likely to tempt other powerful countries, such as China and Israel, into taking military action to settle their territorial disputes.
To see why, consider the famous ethical conundrum described by Michael Sandel, the Harvard philosopher, in his book What Money Can't Buy. An Israeli nursery school introduced fines for parents who collect their children late, inflicting inconvenience on the teachers. But instead of enforcing punctuality, the new system resulted in more late pickups - because parents no longer felt a moral obligation to collect their children on time. Instead they treated the fines as a price worth paying for what they now saw as a babysitting service provided by the school.
By trying to resolve an ethical problem with economics, Sandel's school inadvertently transformed a moral relationship into a commercial one. Similarly, the Western economic sanctions against Russia are turning military-diplomatic issues, such as boundary disputes, into commercial calculations.
President Barack Obama has been explicit about this. He repeatedly uses phrases such as "rising costs" and "calculus…to the Russian economy" in explaining his actions. The effects of trying to substitute economics for military diplomacy are likely to be highly destabilising. For Russia, a weaker ruble and an economic recession are clearly a price worth paying for recapturing Crimea. China will probably draw a similar conclusion about the Diaoyu-Senkaku Islands.
If it was a mistake to turn Ukraine from a military-diplomatic confrontation into an economic one, does this mean that the West should have gone to war with Russia instead of imposing sanctions? The answer is obviously no - and the reasons point to the West's second big strategic mistake.
Modern democracies only consider military action in exceptional circumstances: in response to genuine threats or moral principles, after deep public debate and diplomatic efforts have been exhausted. But here U.S. and European leaders saw economic sanctions as an easy option that would let them dodge the challenges of serious diplomacy and difficult public debate.
Instead, they laid down simplistic and non-negotiable principles - that international boundaries were completely sacrosanct and that only the national government in Kiev could have any democratic legitimacy. This left Ukraine and Russia nothing to negotiate.
Thus the decision to respond to Russia's aggression with immediate economic sanctions had a paradoxical effect. A long and complex diplomatic negotiation about rewriting the Ukrainian constitution might well have produced a compromise reluctantly accepted by all parties. Instead, the Western strategy of substituting immediate economic sanctions for protracted diplomacy, created the conditions for a straightforward military confrontation - which Russia was bound to win outright.
But surely the West can still use its economic power to bankrupt Russia and thus undermine its military might, ultimately reversing its victories in Ukraine? This is certainly possible in the long run, since Russia is a weak economy reliant on imports that it can only finance by selling its oil and gas. This observation leads, however, to a final flaw in the Western strategy of trying to replace diplomacy with economics.
If economic sanctions start seriously threatening Russian wealth abroad, they will play into Putin's hands in the short-term by forcing the oligarchs to repatriate their foreign assets. The long-term effects of isolating Russia economically could be even more perverse.
Russia today is a surprisingly open economy that makes less effort to protect its domestic industries from global competition than many other middle-income countries. Russia's ratio of exports plus imports to gross domestic product, the standard definition of trade openness, is 52 per cent. This is the same as China's ratio, higher than Indonesia's and is almost double the level in Brazil, an economy of roughly the same size and level of development.
If economic sanctions were to force Russia onto a path of greater self-reliance and protectionism, its domestic manufacturing and service industries would almost certainly grow much bigger, even if their quality and productivity fell further behind Western standards.
What would be the political impact in Russia of turning back from a consumer society relying on Western imports into something more akin to Soviet-style self-reliance, Brazilian-style protectionism or South African isolation under apartheid?
Nobody can say for sure, but judging by the experience of other countries that spent years or decades isolated from global markets, it seems likely that the oligarchs would prosper economically in a more protectionist Russia. It is probable that Putin, or an even more aggressive nationalist, would to go from strength to strength in such an autarkic environment, and that Russia's military power would grow, rather than erode.
Certainly not the outcome that economic sanctions are supposed to produce.
Anatole Kaletsky is an award-winning journalist and financial economist who has written since 1976 for The Economist, the Financial Times and The Times of London before joining Reuters. Anatole is also chief economist of GaveKal Dragonomics, a Hong Kong-based group that provides investment analysis to 800 investment institutions around the world.  Any opinions expressed here are the author's own.