The use of targeted sanctions has been arguably the central response of U.S. foreign policy against Russia since the annexation of Crimea in 2014. U.S. government officials have touted sanctions as having imposed heavy but targeted economic costs on the Russian economy and deterred Moscow from further malign behavior. Yet critics of sanctions policy point to evidence of their failure as reflected by the seeming resilience of President Vladimir Putin’s regime and a continued disappointing record of Russian foreign policy actions, such as interventions in Ukraine and Syria, the suppression or assassination of dissidents (including the recent sentencing of Alexei Navalny) and interference in U.S. elections.
Paradoxically both supporters and critics of U.S. sanctions policy against Russia are correct. This seeming contradiction can be resolved, in my view, by empirically tracking sanctions’ exact impact. Such an analysis, described in detail below, shows that the pecuniary cost of sanctions to Russia has been larger than previously estimated, but these sanctions have had an effect on domestic politics that is not necessarily favorable to U.S. interests. Namely, the Russian government’s attempts to protect economic sectors it considers strategic have made the country’s powerful elites even more dependent on the Kremlin, while the bottom-line costs are borne by ordinary people.
In a newly published study of the impact of U.S. and EU sanctions against Russia using firm- and individual-level data, my co-author Dr. Rodney Ludema of Georgetown University and I track over 500 firms sanctioned either directly or indirectly (via association with a sanctioned individual) from 2014 compared to a control group of over 80,000 similar but non-sanctioned firms. We find that the sanctioned firms have been hit very hard relative to their non-sanctioned peers, on average losing a quarter of their operating revenue. A simple aggregation of observed lost revenue would amount to roughly $95 billion, or 4.2 percent of Russia’s pre-sanctions 2013 GDP.
Furthermore, this number, large as it is, may actually be an underestimate due to the endogenous response of the Russian government to “shield” certain strategically valuable companies, primarily in the finance, defense and technology space, such as VTB Bank or the Almaz-Antey missile maker, by diverting resources in the form of tax breaks, government contracts and direct capital injections to mitigate the impact of sanctions. Controlling for the additional burden to the Russian government from shielding these sensitive targets raises the overall cost to about $180 billion, or 8 percent of Russia’s pre-sanctions GDP, significantly larger than previous estimates.
Somewhat surprisingly, this impact resulted not from the denial of market access to Russian exporters, but from the denial of Western services to Russian clients. Russia’s primary export to the West was hydrocarbons, which are fungible in that they can be redirected to other consumers. And Western sanctions did not directly target Russia’s oil and gas exports. Instead, our study suggests it was the denial of Western service imports into Russia, particularly financial services and key technologies, that caused the dislocation. This is remarkable given that Western service inputs on average contributed less than 1 percent of value added to Russian economic production every year.
The shielding described above also explains why the Russian government has remained so intransigent despite the heavy economic toll of sanctions: By shifting the burden away from the sanctions target and ultimately onto the Russian taxpayer, the Putin regime can not only dilute the impact away from sensitive and strategic sectors but also, by shoring up elites, binds them even more tightly to the regime. Of course, the Russian people have paid for this with excoriating inflation, lower living standards and poorer quality public services, but the regime remains resilient.
Going forward, the Biden administration must recognize these hard underlying truths when assessing new sanctions policies against Russia. Yes, sanctions have caused large and quantifiable economic harm to Russian targets. But for their most sensitive targets, the authoritarian regime is able to reallocate resources to bail out oligarchs and Putin associates, enhancing their control over the “commanding heights” of the economy while blaming the West for the general economic misery of the Russian people.
Today, the Russian economy looks quite different than it did in 2014, when the targeted sanctions largely began: The country’s economic institutions are credible; macroeconomic vulnerabilities are low; buffers such as foreign currency and gold reserves have been expanded from a $300 billion low in 2015 to over $400 billion currently; and, in my view, the Russian economy seems much less reliant on Western capital services.
The new Biden administration would do well to recognize the increasingly diminishing returns to each new sanctions action against Russia and also recognize that sanctions have affected the internal political economy of Russia in unforeseen ways not necessarily favorable to U.S. foreign policy.
Instead of simply adding to the quantity of sanctions, the Biden administration should focus on improving their quality by considering their potential consequences. A sanctions target would likely see significant economic harm only if it is dependent upon key Western inputs for which substitutes are difficult to find. So the Biden administration should find strategic targets that are dependent on Western inputs, but also take steps to ensure Western services remain competitive instead of being outcompeted by service providers from, say, China.
Should the Putin regime bail out some of these targets using taxpayer money (which is inevitable), a critic should not blame the sanctions for not working, but instead seek ways to highlight this unjust reallocation of resources to the Russian people. Recent protests in Russia suggest people are unhappy with their lackluster economic prospects. This feeling can be powerfully amplified if the regime’s narrative that Western sanctions are the cause can be shown for the blatant hypocrisy it is.