Economic sanctions: Can a war of arms and a peace of commerce co-exist?

Sanctions imposed right after the Russian war on Ukraine have made compliance operations more complex. Where is this situation headed and what can we expect on the geopolitical risk side? Krishnan Ranganathan, Executive Director with Nomura, examines the history of sanctions to provide insight into the future of geopolitics and their impact on business operations.

In 1998, President Clinton mourned that US was “in danger of looking like we want to sanction everybody who disagrees with US”. In his 2022 State of the Union address, delivered a week after Russia’s invasion of Ukraine, President Biden lauded the “powerful economic sanctions” that the West had imposed on Russia. Biden warned, Putin “has no idea what’s coming.” This year, Biden didn’t even mention sanctions in his speech. His silence was not surprising.

Over the past two decades, US has imposed more sanctions than the EU, UN and Canada combined. This reliance would make sense if they were effective but the history of sanctions is largely a history of failures.

Sanctions are not a new phenomenon. In 432BC the Greek general Pericles imposed a blockade against the city of Megaria to protest against the abduction of three women. In 1806 Napoleon imposed an embargo against British trade to asphyxiate Britain’s economy. The British quietly developed smuggling routes to Europe. Two centuries later, the lesson still holds. “A nation boycotted is a nation that’s in sight of surrender,” President Woodrow Wilson said in 1919. “Apply this economic, silent, deadly remedy and there will be no need for force.” Article 16 entered into force in 1920 and the “economic weapon” would be used by the League of Nations to bring wayward countries to senses. As Prof Nicholas Mulder of Cornell pithily remarked, much was expected of it – perhaps too much.

In 1921 a political crisis was brewing over the independence of Albania that was threatened both by internal instability and the expansionist advances of Yugoslavia. Fixing the northern border between the nations, a process begun in 1913, was incomplete when WWI erupted, and the task remained unfinished. By September, a Yugoslav ground offensive had destroyed 157 villages and endangered Albania’s survival. On Nov 17, the British ambassador delivered PM Lloyd George’s threat of economic sanctions. Before the month ended, Yugoslavia had withdrawn its troops. The mere threat of sanctions induced its government to back off meekly. A depreciated dinar and a humiliated general were small prices to pay for the preservation of peace in a tiny Balkan state. But would a dictator of a medium-sized power bow to a sanctions threat? This question arose sooner than the deterrence believers expected.

In 1923, the Italian general Enrico Tellini was killed by bandits in Greece. Mussolini demanded an apology and damages from Athens. On refusal, Mussolini bombarded Corfu landing a five-thousand-strong army. The British government instantly explored the imposition of sanctions as it had done earlier during the Yugoslavia-Albanian war. Britain had a strong desire to apply sanctions but the administering bodies were hesitant: without US participation in an embargo, the Italians would continue to access world markets. A section of the US media was condemnatory, but there was little appetite for action against Mussolini. Luckily, the Conference of Ambassadors negotiated successfully; Greece apologised and acceded to most Italian demands thus handing Mussolini a victory for Italian honour. But the incident showed that even a dominant maritime power like Britain could not effectively implement sanctions wholly by itself. With no US in the League, British sanctions risked forcing the empire to block the foreign trade of the world’s largest economy. What was possible against Yugoslavia in 1921 proved difficult against Italy in 1923. The League sanctions also failed to deter Italy from invading Ethiopia in 1935 or stop any other belligerent act that led to WWII. Indeed, the US embargo on fuel and war materials going to Japan had precipitated the Pearl Harbor attack.

According to sanctions expert Agathe Demarais, four factors determine if sanctions work:

• how long they’ve been in place;
• do they have a narrow objective;
• does the US have existing trade ties with the target country;
• are allies on board?

This is the exact opposite of most US sanctions programs; no wonder many are doomed to fail. Policymakers have equated effects with efficacy. Just as generals (wrongly) relied on bodies as metric of success in the Vietnam War, policymakers now use the pain inflicted by sanctions as success indicator.

Russia has held up much better economically despite the sanctions. Russia’s economy contracted by >2% in 2022, but a dip not as severe as initial estimates of a >10% crash. The steady rise in crude prices since July 2023 combined with its success in circumventing the cap and reducing the discount on oil mean more oil revenues will be flowing into the Kremlin’s war chest. Far from being an epitaph to Russia’s economy, the sanctions are hurting the interests of US and its allies struggling with inflation. Germany, the largest economy in Europe, is once again called the “sick man of Europe”. Sanctions have also incentivised the “Global South” to find alternatives to the mighty dollar via bilateral swaps, CIPS, digital yuan etc. These are unlikely to have an impact on their own but what matters is that these sanctions-busting innovations exist that could fragment the global financial landscape and erode the power of American financial statecraft. Targets also respond with retaliatory sanctions that imposes costs on US producers and consumers.

European resentment of US sanctions dates back many decades. President Trump's 2018 exit from the Iran nuclear deal was the “straw that broke the camel’s back”. The well-respected risk analyst Maximilian Hess sees other problems too:

• All 27 EU member states have to adopt sanctions unanimously. By the time they approve, the packages are significantly watered down.
• There is no European agency responsible for implementation. Some states may be more lenient than others in granting exemptions. Seven members, including France and Germany, have waived penalties on the EU-based subsidiaries of some of the Russian banks that fell under European sanctions after Russia's annexation of Crimea.
• Brussels believes US sanctions undermine Europe’s sovereignty and credibility. US secondary sanctions mean European firms often have to prioritise respect for US demands over EU laws. The apparent willingness of European judges to overturn sanctions doesn’t reassure Washington, either.
• The threat of war fatigue looms, and Europe’s economic challenges offer an opening for populist parties looking for a strategic benefit to partner with Moscow. Hungary and Serbia wish to continue importing Russian gas leaving the South Stream routes into Europe open and any endangerment would be considered a casus belli. Austria’s far-right Freedom Party remains an electoral force and could grant Russia a route back to Central Europe’s main gas hub. Also, pro-Putin parties are at the heart of Italy’s ruling coalition.

In summary, despite significant cooperation in 2022, the long-term outlook for transatlantic collaboration on sanctions is hardly promising.

A most generous 2014 study by the University of North Carolina found that, at best, sanctions lead to concessions between 33% and 50% of the time. A 2019 Government Accountability Office study concluded that not even the federal government was necessarily aware when sanctions were working. But this has not affected its frequency of use.

To paraphrase Sun Tzu, the best sanction is the one that never has to be applied. Sanctions are specialised instruments “best applied in controlled situations like a scalpel and not a Swiss Army knife”. US needs to remind the world that it is more than a one-trick pony.

Krishnan Ranganathan is an Executive Director with Nomura and is responsible for the execution of global regulatory and transformation projects across Risk, Finance and Operations in Nomura India. He is an alumnus of Harvard Business School and is a member of the Young Scholars Initiative at the Institute for New Economic Thinking. Views are personal.