Blog Post

The cost of escalating sanctions on Russia over Ukraine and Crimea

Sanctions are not about showing the other how much damage can be inflicted on the sanctioned party, but about demonstrating how much pain can be tolerated by the sanctioner. If the EU wants to go all-out over Crimea, stopping gas imports from Russia would be a powerful signal with limited long-term consequences 

By: Date: November 11, 2014 Topic: European Macroeconomics & Governance

The United States and the European Union responded to Sunday’s Crimea referendum – which overwhelmingly backed union with Russia – by imposing sanctions on Russia. So far, 21 Russian and Ukrainian officials, allegedly responsible for the sovereignty transgressions, have been slapped with asset freezes and travel bans. EU leaders will meet again on March 20-21 to discuss possible additional sanctions

Sanctions and retaliation are obviously a negative sum game. If countries stop their cooperation in certain areas, both sides lose. Sanctions are part of a political game of escalation in which both sides signal how much value they put on an issue. The west seems to have a better hand (sanctions hurt Russia more than they hurt the west) but Russia seems to put a higher value on union with Crimea, so the outcome is unclear.

Furthermore, the heterogeneity of EU member states’ interests (see below) raises doubts within the Kremlin about how determined the EU will actually be. It is precisely because of this ambiguity of positions that the escalation game is being played – if the outcome was clear, everybody would be better off by not playing this game.

Interactive map (click a variable to display the data overlay, hover a country to display details – Internet Explorer 8 or above, works best with Chrome)

Map sources: Imports, Exports and Trade data: IMF. 2012 data. Gas Imports (Imports from Gazprom) and Russian Gas Export data: Gazprom, Sberbank Investment Research 2014. 2012 data Gas Consumption: Eurostat. 2012 data Financial Exposure (Consolidated foreign claims on ultimate risk basis) over nominal GDP: BIS table 9D and IMF. Outstanding amounts as of September 2013, except for Austria (September 2012). Foreign Direct Investment: IMF. 2012 data.

What further sanctions?

The type, timing and size of sanctions is a political calculation. Both sides want to convince the other that they are willing to go furthest. Sanctions could range from targeted and time-limited visa bans for certain persons up to full-blown economic sanctions against the entire country.

The direct cost of sanctions is often less important than the losses in terms of mutual trust. For example, the economic cost of not delivering/purchasing an agreed amount of natural gas can be limited, given that storage can buffer the impact of such a trade disruption. But exploiting the vulnerability of a trade partner can cause mistrust that might persist long beyond the end of the actual conflict.

Sanctions against certain ‘influential’ oligarchs might have the side-effect of weakening political support for the Kremlin’s policy. But one might equally argue that this would not work because the security of the oligarchs’ assets (and maybe more, as Mikhail Khodorkovsky found out) seems to depend on the good-will of Putin, not vice-versa. In fact, it is much more likely that targeted Russian sanctions against EU member states with a less pronounced interest in the political issues at stake (eg Germany) might undermine European political unity.

Different impact in different member states

A single country (Russia in this case) might find it easier than a group of countries with very different preferences to devise a ‘convincing’ strategy. The economic and political cost and the political benefits of sanctions are very unevenly distributed between European member states, and will depend on the type of sanctions.

Sanctions targeting Russian financial assets might have a substantial impact in southern Europe (see an extensive discussion in Silvia’s blogpost on Russian roulette). The distribution of the impact of trade sanctions can be approximated by Russia’s share of the foreign trade of different member states. The cost seems to mainly fall onto the countries of the eastern belt of the EU, from Finland to Greece, with the notable exception of Romania, which is less affected. In relative terms, Germany would not be more affected than the Netherlands or Sweden. Sanctions targeting only Russian gas imports would have a much more substantial effect on the same group of countries. In addition, the central-west European countries Germany, Italy, France and the Netherlands would be affected by this. Finally, in terms of financial exposure (in the map: consolidated foreign claims on ultimate risk basis relative to GDP), Austria sticks out.

The distribution of the cost of sanctions depends on the type of sanction chosen. This is bad news for building a persuasive European negotiating position, because when it comes to distribution of cost, Europe often prefers a lowest common denominator approach.

What should Europe do?

Before any decision on sanctions is taken, Europe should clarify what it wants to achieve with sanctions. Possible political goals are to reverse Russia’s de-facto annexation of Crimea, to prevent Russia from going beyond Crimea or to just save face.

Then, the leaders of the European Union should understand how far each of them would be willing to go. If the member states cannot commit to the level of sanction-induced costs that would have a realistic chance of changing Putin’s mind, Europe will have to restrict itself to symbolic measures to avoid unnecessary losses.

If the EU is willing to accept the increasing costs of the escalation, the first step should be to give a convincing signal of unity and determination – otherwise it will be seen as an invitation to test Europe’s strength. Taking incremental steps might take too long, and would make the big steps look small. If escalation is spread over a long period of time, it might also on aggregate inflict more economic damage, and on-going rhetoric might reduce the political room for both sides to come back to the table. By contrast, a determined step could shorten the escalation period and could allow normal cooperation to be resumed quickly after the crisis.

Sanctions are not about showing the other how much damage can be inflicted on the sanctioned party, but about demonstrating how much pain can be tolerated by the sanctioner. If the EU wants to go all-out over Crimea, stopping gas imports from Russia would be a powerful signal with limited long-term consequences (a similar proposal has been made by David Böcking).

Europe might not be able to fully replace the 130 billion cubic metres it imported in 2013 at sufficiently low cost. But the Russian economy would be severely hit. At an average sale price of US$350 per thousand cubic metres, the annual loss in Russian revenues would be in the order of US$70 billion or three percent of GDP.

With this step, Europe would defuse Russia’s gas weapon at a stroke. Most importantly, when normal economic relations are re-established, the long-term impact of this episode would be minor. Russia will remain an important source of gas for Europe, simply because it is so uneconomic for Russia to diversify its gas exports.

Finally, it is much more powerful for Europe to stop imports, compared to a scenario in which Russia stops exports of natural gas. Stopping gas imports is an expensive signal – but a high price is the precondition for demonstrating determination. Such a bold strategy could obviously only work if energy solidarity inside the EU is ensured.

Research assistance by Michele Peruzzi and Carlos de Sousa is gratefully acknowledged.

 


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

View comments
Read article More on this topic More by this author

Podcast

Podcast

Backstage: The new balance of Asia-EU-US trade relations

Amid the Asia-Europe Economic Forum on the fringes of the 12th ASEM Summit, Bruegel senior fellow hosts a conversation on developing global trade relations, with guests Moonsung Kang, professor as Korea University, and Michael G. Plummer, director at SAIS Europe – Johns Hopkins University, for an episode of the Bruegel Backstage series on ‘The Sound of Economics’.

By: The Sound of Economics Topic: Global Economics & Governance Date: October 17, 2018
Read about event

Past Event

Past Event

Policy responses for an EU-MENA shared future

In the third edition of the "Platform for Advanced & Emerging Economies Policy Dialogue" we will discuss trade flows and trade policy between Europe and MENA, integration of developing economies into global value chains, and regional energy relations.

Speakers: Karim El Aynaoui, Marek Dabrowski, Uri Dadush, Ignacio Garcia Bercero, Ettore Greco, Giuseppe Grimaldi, Badr Ikken, Joanna Konings, Said Moufti, Pier Carlo Padoan, Lia Quartapelle, Visar Sala, Nicolò Russo Perez, Nicolò Sartori, Simone Tagliapietra and Guntram B. Wolff Location: LUISS Business School Viale Pola, 12, 00198 Roma RM, Italy Date: October 11, 2018
Read article Download PDF More on this topic

External Publication

The EU response to US trade tariffs

The authors contributed to the new issue of 'Intereconomics - Review of European Economic Policy' with a paper on the EU's strategy for managing the trade war. The authors argue that to minimise the economic costs of the trade war and protect multilateralism, the EU's best and only response is to retaliate.

By: Maria Demertzis and Gustav Fredriksson Topic: Global Economics & Governance Date: October 11, 2018
Read article More on this topic More by this author

Blog Post

Are economic and political freedoms interrelated?

Democracy has not always accompanied market economy. But in modern societies, economic and political freedoms are increasingly interconnected. Democracy and market economy can support each other. This is particularly true in post-communist economies of Central and Eastern Europe and the former Soviet Union. Thus, authoritarian tendencies observed in these and other regions can negatively affect quality of economic policy and governance.

By: Marek Dabrowski Topic: Global Economics & Governance Date: October 10, 2018
Read article More on this topic More by this author

Podcast

Podcast

Backstage: Implications of the new EU-Japan trade deal

Bruegel senior fellow André Sapir welcomes Tamotsu Nakamura, dean of Kobe University’s Graduate School of Economics, and Maria Åsenius, head of cabinet to European trade commissioner Cecilia Malmström, for a discussion of the EU-Japan economic partnership in the context of heightening global trade tensions.

By: The Sound of Economics Topic: Global Economics & Governance Date: October 4, 2018
Read article Download PDF

External Publication

European Parliament

The EU - Japan Economic Partnership Agreement

This paper was requested by the European Parliament's Committee on International Trade (INTA) and analyses the EU-Japan Economic Partnership Agreement (EUJEPA).

By: André Sapir, Sonali Chowdhry and Alessio Terzi Topic: European Parliament, Global Economics & Governance, Testimonies Date: October 3, 2018
Read about event More on this topic

Past Event

Past Event

International trade and the EU-Japan Economic Partnership Agreement

This event; jointly organised by Bruegel and the Graduate School of Economics, Kobe University, will discuss the EU-Japan trade deal and asses its impact.

Speakers: Maria Åsenius, Sonali Chowdhry, Gabriel Felbermayr, Hiroo Inoue, Sébastien Jean, Yoichi Matsubayashi, Tamotsu Nakamura, Masahiro Nakata, Luis Portero, André Sapir, Alessio Terzi, Agata Wierzbowska and Guntram B. Wolff Topic: Global Economics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: October 3, 2018
Read article Download PDF More by this author

Parliamentary Testimony

Belgian Federal ParliamentCroatian Parliament

Transatlantic relations

Testimony before the Belgian Federal Parliament ( La commissions des Relations extérieures de la Chambre des représentants )

By: Maria Demertzis Topic: Belgian Federal Parliament, Croatian Parliament, Testimonies Date: September 27, 2018
Read article Download PDF More on this topic More by this author

External Publication

LNG and Nord Stream 2 in the context of uncertain gas import demand from the EU

Georg Zachmann sees the development of import demand for natural gas in the EU as uncertain. In case of strongly increasing import demand, both Nord Stream 2 and liquified natural gas imports could contribute to ensure European supply.

By: Georg Zachmann Topic: Energy & Climate Date: September 27, 2018
Read article More on this topic More by this author

Blog Post

Something Putin and Juncker appear to agree on – the euro

“It is absurd that Europe pays for 80% of its energy import bill – worth €300 billion a year – in US dollars when only roughly 2% of our energy imports come from the United States,” said President Juncker in his state of the union speech.* Europe’s largest supplier of energy – Russia, who accounts for a third of that bill – couldn’t agree more. Russia’s offer to switch to euros in trade with the EU will likely be costly to implement, but the US switch towards unilateralism is forcing its long-standing partners to question the dollar’s global dominance.

By: Elina Ribakova Topic: European Macroeconomics & Governance Date: September 25, 2018
Read article More on this topic More by this author

Podcast

Podcast

Backstage: Developing the EU-China relationship amid rising global trade tensions

Bruegel director Guntram Wolff is joined by Alicia García-Herrero, senior fellow at Bruegel, and Zhang Weiwei, director at The China Institute of Fudan University, following up a Bruegel conference focused on the potential for closer economic links between China and the EU.

By: The Sound of Economics Topic: Global Economics & Governance Date: September 20, 2018
Read about event

Past Event

Past Event

Bruegel Annual Meetings 2018

The 2018 Annual Meetings will be held on 3-4 September and will feature sessions on European and global economic governance, as well as finance, energy and innovation.

Speakers: Maria Åsenius, Richard E. Baldwin, Carl Bildt, Barbara Botos, Maria Demertzis, Benjamin Denis, Lowri Evans, Mariya Gabriel, Svend E. Hougaard Jensen, Joanne Kellermann, Jörg Kukies, Emmanuel Lagarrigue, Philippe Lespinard, Rachel Lomax, Dominique Moïsi, Jean Pierre Mustier, Ana Palacio, Jean Pisani-Ferry, Lucrezia Reichlin, Norbert Röttgen, André Sapir, Johan Van Overtveldt, Martin Sandbu, Margrethe Vestager, Reinhilde Veugelers, Nicolas Véron, Thomas Wieser, Guntram B. Wolff and Georg Zachmann Topic: Energy & Climate, European Macroeconomics & Governance, Finance & Financial Regulation, Global Economics & Governance, Innovation & Competition Policy Location: Brussels Comic Strip Museum, Rue des Sables 20, 1000 Brussels Date: September 3, 2018
Load more posts