How sanctions on Russia could backfire

Since Vladimir Putin’s nefarious invasion of Ukraine, Russia has been expelled from the Western financial system and punished with various international sanctions. Politicians often view these measures as a relatively quick and painless way for law-abiding countries to penalize offenders. But history shows that their effectiveness is questionable, and they can sometimes backfire seriously. Furthermore, if there is a country that has shown that it can resist, it is Russia.

According to Nicholas Mulder’s timely new book, The Economic Weapon (The economic weapon), sanctions were first applied by Athens, which imposed a trade veto against the Greek port city of Megara in 432 BC But their use did not take off until World War I, when Britain and France developed a broad economic blockade against Germany and their allies. After the war, sanctions were seen as a tool to keep nations at peace. US President Woodrow Wilson believed the threat was “absolute isolation … that brings a nation to reason.”

The League of Nations was created in 1920 with the power to impose sanctions on countries that break international law. In its early years, there were a couple of successes: Greece and Yugoslavia’s possible incursions into their neighbors were stopped by the Society’s threat to close their foreign trade. The real test came in 1935, when Mussolini invaded Ethiopia. All 58 members of the Society, except six, imposed sanctions on Italy. They cut back on exports to reduce their access to foreign exchange reserves and limit their ability to wage war. But after several months of fighting, Mussolini’s army entered Addis Ababa and the sanctions were lifted.

There are several lessons to be learned from that failure. First, economic weapons are less effective when deployed against large states. Second, early sanctions advocates like Wilson had a naive view of human nature. They believed that populations would desist from aggressive actions when their material interests were threatened. The unfortunate truth is that nations and their rulers, especially autocratic ones, sometimes have other priorities. Third, incomplete blocks are ineffective. Both the US and Germany remained neutral during the Italo-Abyssinian War, and the League of Nations failed to cut off Italy’s oil supplies.

Mussolini’s isolation pushed him into the arms of Hitler. Germany and Japan, fearing that the economic weapon would later be deployed against them, accelerated their quest for self-sufficiency in raw materials. In Germany’s case, that meant moving deeper into Central Europe, annexing Austria in 1938 and all of Czechoslovakia the following year. Hitler even told a foreign diplomat in 1939 that he needed the Ukraine so that the Germans would not starve again. Japan’s desperate need for crude eventually brought it into conflict with the US Thus, sanctions against Italy accelerated the start of World War II.

Now, Russia is the international pariah. Unlike Italy, its abundant natural resources make it extraordinarily resistant to external pressure. Indeed, sanctions were first used against Russia after the Bolsheviks took power in 1917, in what Mulder calls a form of “cheap counterrevolution.” The new regime resisted the siege and even used its trade monopoly to withhold staples from Europe, just as Russia today prevents Ukrainian wheat from reaching foreign markets. By the early 1930s, when the Soviets ceased almost all foreign trade, autarky was complete.

Opposition to Putin is also not unanimous. According to international trade expert Simon Evenett, for every country that sanctions Moscow, there are three that do not, such as China and India. Around half of Russian exports go to these countries. Furthermore, Europe remains dependent on Russian energy. In the last three months, the country’s imports have fallen faster than exports, producing a record trade surplus. Although the West has seized its foreign exchange reserves, the ruble has strengthened against the dollar. Evenett calculates that a European ban on Russian energy imports would permanently reduce its GDP by just 1%.

At the start of the Great War, Russia accounted for a quarter of French investment abroad. President Georges Clemenceau imposed sanctions in a desperate attempt to get the Bolsheviks to fulfill their obligations to the Tsars. The time has changed. Now Washington is actively forcing a Russian default by banning Western banks from receiving money from Moscow. Russian stocks and bonds owned by foreigners have been reduced to zero. Multinationals are selling their Russian businesses at bargain prices.

It is hard to see how the cancellation of hundreds of billions of dollars of foreign investment in Russia is going to persuade Putin to change his behaviour. But these remarkable facts highlight another unwelcome feature of sanctions: they remove traditional legal protections afforded to private property, exposing investors to the arbitrary depredations of the state. Early critics of economic restrictions had an even greater concern. Sanctions, they said, blur the line between a state of war and a state of peace. It is unclear at what point a sanctioned nation will consider further punishment an act of war. George Soros has said that, in his opinion, World War III is already underway.

The long-term danger is that the invasion of Ukraine and sanctions on Russia, like those imposed on Italy a century ago, will give a new impetus to deglobalization, driving Moscow into Beijing’s camp and endangering the system based on dollar. Evenett warns that the advent of a multipolar world could lead to more stranded assets for Western investors. It is not a desirable outcome, but a chain of events has been set in motion that may make it inevitable.