Why Western Sanctions against Russia Work, and How to Make Them Work Better

BY BORIS GROZOVSKI

The Russian economy is facing significant problems because of the West’s sanctions. Since April, the country has lost half its imports. Manufacturing facilities that depend on imported components are struggling or facing a shutdown. The government has increased its war spending, and budget revenues have shrunk. Soon the Kremlin will want peace talks, with a concomitant pause in the fighting, to secure its territorial gains, lighten the sanctions regime, rearm, train new soldiers, and plan a new phase of its war. Such an approach is unacceptable to Ukraine.

To thwart these plans, the sanctions must be kept in place until Russia withdraws its troops beyond the February 24, 2022, lines of conflict. International society must make sure that Russia does not circumvent the imports bans. The price at which Russia can sell its hydrocarbons can be capped, and more restrictions on its imports of capital goods can be introduced. Beyond strengthening sanctions, identifying clear conditions under which sanctions would be eased should help Moscow understand the gravity of the situation and the kind of behavior expected of it in the future, with the goal of reintegrating a peaceful Russia into the global economy.

The War of Sanctions

Many experts believe the sanctions are not working. Russia does not appear willing to stop the war, and the rhetoric of the leadership is only getting more aggressive. Teasing apart export from import sanctions helps disclose the source of concern.

Notably, the export sanctions are not at the moment producing all the results the West sought, though the picture may well change—or be changed. Because of a shrinking oil and gas supply, leading to higher energy prices, the Russian government coffers will see record inflows in 2022. Russia’s current account surplus reached $110.3 billion in January–May 2022, a 3.4 times increase over January–May 2021.

For the coalition supporting Ukraine, this does not look like a stellar result. The world economy needs Russia’s exports. Restricting those exports hurts those who restrict them.

Any sanctions regime is a double-edged sword. Europe plans to spend €200 billion to end its reliance on Russian fossil fuels by 2027. On the other hand, Russia itself has stopped gas deliveries to five countries that were not ready to remit payment in rubles, and has reduced its gas deliveries to Germany. Germany may be forced to declare a state of emergency in the event of a complete Russian gas cut-off.

Weaning Europe from Russia’s energy is expensive and cannot be done quickly. It seems that both sides are treating Russian exports as a weapon, writes Mark Harrison, a military historian. While Europe threatens Russia with a ban on purchases, Russia threatens Europe with an end to sales. Europe's energy relations with Russia, especially Germany's relations, represent fifty years of codependence, and getting out of such a relationship cannot be painless.

The second market in which Russia gives other countries a lot of trouble is grains and the mineral fertilizers needed to produce them. Russia actually is stealing and exporting Ukrainian grain, and some countries are applauding that course of action because they need the grain. Like the energy exports, grain exports will aid Russia’s coffers.

A third market where Russia could manipulate prices is that for the metals used in the production of aircraft, semiconductors, and rechargeable batteries—nickel, platinum, titanium, scandium—some of which are necessary to derive energy from renewable sources. Together with China, Russia could simply paralyze this metals market. Even an accelerated transition to renewables to reduce dependence on Russian hydrocarbons will face many problems if Russia refuses to sell these rare-earth metals. In such a case, just as with oil and gas supplies, the codependent relationship would be extremely difficult to dissolve.

Import Sanctions Work

Unexpectedly for many observers, the sanctions on Russia’s imports have proved much more effective than the sanctions on its exports. Russia stopped publishing foreign trade statistics, so we can use only indirect data. Based on VAT revenues, we estimate that Russia’s imports, since sanctions, decreased by at least 2.3 times. Revenues from import excises and duties decreased even more, by 3.1 times.

Many Russian enterprises and industries depend on imported components and technologies. The share of value added created abroad exceeds 50 percent in the pharmaceutical, auto manufacturing, textile, electrical and electronic equipment, and computer industries. It is 30–50 percent in the metallurgical, chemical, and paper industries. The EU, the United States, and Canada account for about half the foreign value added. In many cases it is not the amount of foreign value added that matters but whether Russia can substitute for parts it formerly imported.

This limitation has meant that after foreign automakers and automotive component suppliers suspended their operations in Russia, Russian car plants were forced to stop operations as well. New car sales in April were almost five times less, and in May six times less, than a year earlier. Russian car plants will now produce cars without airbags, automatic transmissions, or air conditioners.

Russia’s dependence on imported electrical and electronic equipment is extremely high. Microchips and other electronic components from seventy different American and European firms have been found in Russian weaponry. Russian weapons factories say they have big problems with the lack of imported engines, microprocessors, compact and real-time data transmission systems, and optical and thermal imaging equipment. Facing a shortage of imported components, arms manufacturers, such as Russia’s only tank producer, Uralvagonzavod, or the firearm producer Kalashnikov, are slow to fulfill military orders.

American and European producers are blocked from selling aircraft or parts or providing maintenance to Russian airlines. To maintain at least some of their aircraft, Russia’s airlines will have to strip other craft for parts. Even the operation of Sukhoi Superjet 100 aircraft, which uses foreign-made (Franco-Russian) engines, might be halted. Russia’s shipbuilding industry is also greatly affected by the lack of domestic producers of engines and parts.

The modern retail industry has also been badly affected by the sanctions, losing its largest tenants overnight. Suppliers of clothing, perfumes, and other luxury goods are banned from exporting to Russia.

The Russian government has relied on "parallel imports" (the importation of goods into the country without the permission of the rights holder). However, this is only a partial solution. Even China, Georgia, Kazakhstan, and Armenia are unwilling to build bypass corridors and ship goods to Russia because of the secondary sanctions they would in turn incur.

Some sanctions have an immediate impact, but those concerning Russian industry will have a delayed and gradual effect. The sanctions against Russian imports are hitting its economy harder than the sanctions against its exports. It could not be otherwise: Russia has a low national debt and large budget reserves, which can compensate for the drop in exports. It is much more difficult to reconfigure the industrial technologies that were developed based on an expectation of Russia's inclusion in the global economy.

How to Make the Sanctions System More Effective

Russia has never experienced an economic crisis with commodity prices so high. The severance of economic ties with Western economies is bringing many production chains to a halt. Since Gorbachev, Russia has become fully integrated into the global economy. Excluding it now will result in a “dumbing down” of technological processes, resulting in the domestic production of simpler, outmoded goods.

Russia is far behind in such industries as mechanical and automotive engineering, electronics and computers, biotechnology, avionics, and optics. Without investments from developed countries, a technological leap is “an unimaginable experiment,” notes the economist Branko Milanović. Therefore, the main thing that the current system of sanctions does is cut Russia off from advanced technologies. The state budget and economic structure will help the Russian economy survive in a prolonged autarky, but in the long run will doom it to degradation.

As for Russian exports, Western leaders need to accept the reality: there is no surplus in the world of oil, gas, metals, fertilizers, or food. Therefore, an embargo on Russian exports would be expected to lead to shortages of commodities and soaring prices, both extremely unpleasant for consumers. If China and India did not buy Russian oil, its price would be even higher. That is why Chris Miller and Edward Fishman proposed introducing price caps on Russian export goods. The logic is simple: the purpose of sanctions is not to reduce the purchase of Russian goods but rather to decrease Russia's income.

To do this, consumers of energy resources should unite in a “reverse OPEC” and agree on a maximum price at which they can buy Russian oil and gas. Secondary sanctions could be imposed for violating this norm. The price should be below the world price but high enough to stimulate Russia to export. This would lower world oil and gas prices and bring down inflation while limit Russia's export revenues. China and India already buy Russian resources at a discount, so they will like the idea.

Finally, it’s important to make clear which sanctions against Russia would be eased and when. Obviously, a peace treaty that allowed Putin to resupply weapons lost in Ukraine, build its armed forces, and prepare for a new phase of the war is not the goal of Kyiv and Western countries. Being explicit about what is necessary to moderate or lift the sanctions should produce clarity for both sides of the conflict.

Some sanctions could be linked to the restoration of Ukraine’s borders as they were on February 24, 2022. Another group of sanctions could be linked to the return of Crimea and the Donbas to Ukraine. A third group could be associated with Russia’s withdrawal from other disputed territories (including in Moldova and Georgia). A fourth group of sanctions might be eased if Russia agreed to participate in the reconstruction of Ukraine under the control of Kyiv after the war. Seized Russian assets could be used for this purpose. Finally, a fifth group of sanctions should be linked to democratization in Russia itself (ending censorship, releasing political prisoners, restoring political competition, abolishing unjust laws).

Connecting relief from sanctions with specific behaviors should help the West better evaluate the effects of those sanctions while presenting Russia with a path for reintegrating into the global economy.

The opinions expressed in this article are those solely of the author and do not reflect the views of the Kennan Institute.