Sanctioning Russia at What Cost? Potential Economic Implications for EU Member States

Last week, the European Council’s Committee of Permanent Representatives (COREPER) reached an agreement to impose sanctions on the Russian banking and arms sectors, and to some degree the energy sector. The decision marked a turning point, after a five-month debate on the economic risks for EU member states to imposing sectoral sanctions on its third trading partner.

The decision is significant for at least two overlapping reasons. First, sacrificing economic interests to enable a unified, coherent response to alleged international law violations is an unprecedented signal of commitment and political awareness by the EU; as the German Finance Minister recently stated, “Economic interests are not the top priority. The top priority is ensuring stability and peace.” Second, the decision to impose sanctions on one of its main trading partners, might lead to profound economic costs for the Eurozone.

The strong economic interdependence between Russia and the EU questions, as never before, the utility and sustainability of sanctions as a policy tool. Therefore, it is important to explore, with some parallels to the sanctions against Iran, the potential implications for EU member states in terms of growth, trade, and employment, and to address some of the challenges in using sanctions to isolate Russia and in achieving deeper political goals.

It is inherently difficult to estimate, from the outset, how much sanctions will cost a sanctioning state. In the case of Iran, where the EU has imposed significant economic sanctions since 2010, it has been recently reported that the EU lost more than twice as much as the US in terms of trade revenue between 2010 and 2012. To break this down: Germany lost between US$23.1 and US$73bn, with Italy and France down US$13.6 – US$42.8bn and US$10.9 – US$34.2bn, respectively. With the loss of trade, we also need to appreciate the knock-on effect on employment and the broader social impacts across these countries. Russia is a much closer partner to the EU compared to Iran, and if sanctions are not carefully calibrated, there is a high risk of incurring even greater economic costs.

First, GDP growth and economic recovery will suffer given the strong interdependence between Russia and some European countries. According to a Deutsche Bank study, at the outset of the crisis in March 2014, a repeat now of the 8 per cent contraction in output suffered by the Russian economy in the wake of the global financial crisis in 2009 would reduce Germany’s growth rate by half a percentage point.

Second, the loss of trade, especially with regard to the oil and gas sector, will be significant. Compared to the US, the volume of EU trade with Russia is ten times higher. More than 45 per cent of Russia’s exports go to Europewhile only 3 per cent of the EU’s exports go to Russia. Germany, the strongest European economy, gets 30 per cent of its oil and gas from Russia and the total value of German exports to Russia was €38bn in 2013. The EU overall imports 150bn cubic metres from Russia, and the loss of Russia’s present level of crude oil exports is 7m barrels a day, which risks triggering a sharp rise in the price of oil and perhaps even a global economic slump. By contrast, the sanctions against Iran caused a loss of 2.5m barrels a day.

Last, the imposition of tougher sanctions on the trade sector threatens the loss of jobs. Hundreds of French workers have been employed because of a US$1.7bn deal to sell two Mistral warships to Moscow, which France is trying to preserve despite the arms embargo. In Germany, one truck driver put it bluntly: “Economic sanctions don’t work, and we depend on Russian oil here. Jobs depend on it.” For some of the smaller European countries that provide offshore financial services, flows of funds from Russia are an essential source of revenue. According to data from the Bank of Russia, Russian individuals moved more than US$33bn to Cyprus, Ireland and Luxembourg only last year.

As never before, European countries are trying to design sanctions in a way to punish the target state with minimal impact for their economies. The UK has been working since March on a mitigation plan, especially for the City of London. Despite such careful provisions, the outcome and impact will always be unpredictable and difficult to control. Across the member states, citizens and the private sector may in due course regard breaking ties with Moscow to be too much of an economic risk, especially given the inevitable repercussions for growth, trade and jobs.

Drawing upon recent history, sanctions have rarely achieved their objectives or led to a positive impact inside or outside the targeted state, as demonstrated by the fragile economies of Iran and Iraq. Moreover, sanctions rarely succeed in isolating the target state, especially if the latter has a strong economy and can offer opportunities for investment outside of the sanction net. This was true for Iran and might be even more likely for Russia. Looking specifically at the oil sector, while the EU has not yet succeeded in limiting its dependence on Russian provisions, Moscow has been increasingly looking to the East. On 21 May 2014 Russia signed with China a 30-year gas deal, estimated to be worth some US$400bn. Russia has also expanded ties with two of its regional allies, Kazakhstan and Belarus, and founded on 29 May the Eurasian Economic Union.

The present case of Russia is unique given its political and economic weight and the level of interdependence with the EU. Therefore, it provides an unprecedented opportunity to test whether economic sanctions can be used in an efficient way, if coordinated and planned to limit their collateral effects. While it may be imperative for the EU to maintain a tough stance on Russia, European leaders have to consider very carefully the full economic and social costs they are willing to pay before any further escalation. Learning from the high costs and the mistakes committed in imposing sanctions against other states, like Iran, is an essential part of this process. Such examples tell us that sanctions, without sufficient political engagement and the continuous monitoring of progress, are simply not conducive in achieving the end goals of stability and peace.

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