The West has got its Russia sanctions wrong

NEW YORK: The West responded to Russia’s invasion of Ukraine with sanctions of unprecedented severity and scope. By the standard of proportionality, the reaction of the United States, the European Union, and their allies seems appropriate.

Serious international aggression demands a serious response. But by the standards of consistency, efficiency, and fairness, it is far from clear that the West has chosen the correct strategy. Governments may need to rethink the design of the sanctions regime.

So far, Western commentary has focused on the strength of the punitive measures.

These have targeted trade, by restricting exports of technology and imports of Russian oil and gas; finance, by preventing transactions by designated Russian banks; official assets, by freezing much of the Russian central bank’s foreign-exchange reserves; foreign investment, by forcing Western firms to cease operations in Russia; and personal assets, by expropriating possessions of Russian oligarchs and officials.

Many have argued for even stronger sanctions.

The EU, for example, is currently trying to reach consensus on phasing out imports of Russian oil by the end of 2022, on the grounds that payments for these supplies are funding the Kremlin’s war machine.

As Russia escalates its attacks on Ukraine, the West should probably ratchet up its response as well. But policymakers must first answer a more fundamental question: Is the current sanctions strategy truly serving the West’s interests, or are there better ways to achieve the same goal?

In war, ends may overwhelm means. When the survival of the international order itself is at stake, as it is now, it may seem as if ends are all that matter. But when the fighting in Ukraine eventually stops, the means that the West has employed will have consequences.

So, even in extremis, countries that uphold democracy and the rule of law must strive to adhere to certain principles.

For swearing expropriation should be a key tenet, but the West violated it by effectively seizing Russian official foreign reserves, annulling claims on Western goods and services that Russia had legitimately acquired over time. Such retroactive confiscation is one of the worst kinds of expropriation.

The ramifications of this decision may not be visible today, but the damage will become apparent over time. Other countries might be less willing to hold reserves in US dollars or euros, or deal with US banks. And some large countries, such as China, might one day be tempted to apply the same measure against the US, citing the current expropriation as a precedent.

More broadly, freezing Russia’s foreign reserves has damaged trust in the very international system that the West aims to preserve.

True, the sanctions on Russian trade and financial activities are not retroactive.

But they reflect a misdiagnosis. The Western sanctions aim to inflict economic pain on Russia by depriving it of basic inputs and consumer goods.

Russia is a classic commodity producer, with relatively limited manufacturing capacity. It exports oil and gas, while importing inputs to supply its factories and consumer goods to satisfy its population’s needs. The sanctions are intended to curtail those imports, thereby reducing Russia’s productive capacity and hence its ability to wage war.

But seeking to curb the ways in which Russia can accumulate hard currency is a remarkably indirect way of reducing the country’s imports.

There is a much more straightforward means of reaching this objective: restricting supplies from the West. Under this strategy, the West would continue to buy oil and gas from Russia, but would not provide any goods in return.

Already, the US and the EU have banned exports of high-tech and dual-use products, which could be used by Russia’s military. This list should be widened to encompass all exports. And diplomatic efforts should focus on expanding the number of countries participating in the export boycott.

To ensure its legality, the World Trade Organization’s national-security exception should be invoked.

Of course, Russia would still accumulate dollars and euros, which it could use to pay for imports from other countries, such as China.

But Russia would not find it easy to switch suppliers, because Europe, the US, and their allies currently account for more than 50% of the country’s imports.

For example, the French automaker Renault appears poised to offload its majority stake in Avtovaz, Russia’s largest automobile producer, and to stop supplying it with parts and machinery.

Redesigning the Lada manufacturer’s cars and assembly lines will take time and resources, and in the meantime, production will grind to a halt. Russia could of course respond by trying to import Western goods from third-country suppliers. But again, this would not be easy.

The US has a system for monitoring such diversions, and has already warned other countries that it will “bring the full force of the law to hold accountable those that knowingly violate the new rules.”

Russia might also consider responding by stopping its exports of oil and gas. But in the end, doing so would be far too dangerous to its strategic interest.

After all, if it stopped accumulating foreign exchange, it would be unable to import anything at all, from any country.

Aside from efficiency, shifting to a supply-based sanctions strategy would have three other advantages.

First, restricting exports to Russia – which account for only a small proportion of European and US exports and a smaller share of production – would reduce the costs of sanctions to the West and be far less disruptive to the global economy than ending energy imports from Russia.

Second, an export-oriented approach would allocate the costs of sanctions more fairly. The burden would shift from European energy consumers to the far smaller number of Western firms exporting to Russia, which are much more able to absorb the costs.

Finally, restricting exports to Russia would result in fairer burden-sharing among the countries imposing sanctions.

The current approach favours Germany at the expense of the US – but not in the obvious sense that Germany is still able to import gas from Russia.

The reason is that German firms can continue to supply the Russian market, whereas the financial sanctions are undermining trust in US financial markets and banks, and in the US government itself.

The US has carried the load for Germany in order to deal with what is primarily a European problem.

In effect, Germany has managed to invert former US Treasury Secretary John Connally’s famous quip directed at Europe about the dollar being “our currency, but your problem.”

Dollar-related sanctions have become America’s problem and Germany’s solution.

Russia’s illegal military action can and should be countered by an economic response that is principled, effective, fair, and legal.

The West can achieve such a response by replacing its current sanctions with comprehensive and collective restrictions on exports of goods to Russia.