Year: 2023

“We fled when we could. I only took my laptop and a few clothes with me.” Vitaly {the source’s name has been changed}, a 34-year-old Russian software engineer, remembers leaving his home on the outskirts of Moscow with his wife last February as a bad dream. Having found a job at an IT firm in Europe, he does not expect to get back soon. His former employer lost 70 percent of its clientele within a few days of the war in Ukraine starting, a side effect of massive sanctions on Russia.

In a bid to pressure Vladimir Putin to withdraw his troops, most NATO members have taken a wide range of measures, from energy import bans to freezing the country’s foreign currency and gold reserves stored in Western banks. However, it is the brain drain, intensified after the partial mobilisation announced last autumn, that is expected to inflict more lasting damage on the Russian economy, depriving it of skilled workers like Vitaly. “Many of these people are young men fleeing mobilisation. They do not want to take part in the conflict,” says Armand Arton, CEO of Arton Capital, a Canadian consultancy that facilitates second citizenship acquisition.

The firm has seen a rise in the number of Russians seeking to obtain a second passport, a sign that they are out for good. Unlike the affluent businessmen who would previously go down that route, most are professionals aiming to build a life overseas, according to Arton.

Sanctions against rockets
Although economic sanctions have a long history, traced back to ancient Greece, it was mainly after the Second World War that they were utilised to put pressure on rogue states without resorting to military means. Data collected by researchers at Drexel University show that sanctions rose from two in 1949 to 230 in 2019, with the US accounting for nearly half of them. Following the attacks of September 11, 2001, the US unleashed an unprecedented ‘War on Terrorism’ on terrorist organisations and countries such as Iraq, Iran and North Korea, dramatically increasing the use of sanctions. A tacit recognition that they led to humanitarian crises precipitated a gradual move towards more ‘targeted’ sanctions focusing on businessmen, politicians and state-run firms.

Seizing yachts from oligarchs or making it more difficult for them to drive their Ferraris around London is not going to change Russia’s behaviour

The conflict in Ukraine has rekindled the debate on whether sanctions work against authoritarian regimes where public opinion matters little and rulers can use the ‘rally round the flag’ effect to consolidate their power. For some experts, sanctions are mainly a domestic policy tool, often aimed at placating politically powerful minorities, such as the Cuban community in Florida. In some cases, as with the pre-Second World War US fuel embargo against Japan, they have increased tensions. More recently, renewed US sanctions on Iran, following the Trump administration’s withdrawal from an accord on the country’s nuclear programme, had little effect.

However, some point out that it was sanctions that had previously brought Iran to the table. “I spent many years having everybody explain to me that sanctions could never impact Iran’s behaviour. Now the only thing everybody agrees about in regard to Iran is that sanctions worked,” says Daniel Glaser, who helped formulate sanctions against Iran, North Korea, Syria and Russia as former Assistant Secretary for Terrorist Financing and Financial Crimes at the US Treasury, adding: “Over time they create economic problems that even authoritarian governments have to grapple with.” Even a leader whose power is virtually uncontested domestically, like Putin, cannot ignore their long-term impacts. “There is a social compact between the Russian people and their government that they will tolerate whatever the government is up to as long as it delivers on certain things, especially economic wellbeing. He is now putting that compact at grave risk,” says Glaser, currently global head of jurisdictional services at K2 Integrity, a risk advisory firm.

The avalanche of economic sanctions has already taken its toll on the Russian economy. According to Yale University’s sanctions tracker, over 1,000 foreign firms have curtailed operations in the country or pulled out altogether, creating gaps in supply chains and leading to a drop in consumer spending of up to 20 percent. Russia’s non-energy exports have plummeted, while many of its industries have ground to a halt. By May, its car manufacturing industry had slumped by a staggering 97 percent compared to the previous year; it may never recover, according to Konstantin Sonin, a Russian economist who teaches at the University of Chicago. The IMF forecasts that Russia’s economy will contract by 3.4 percent this year.

Some sanctions target billionaires with connections to the Kremlin, the so-called ‘oligarchs.’ However, most analysts believe that such measures make only a symbolic contribution, given Putin’s shrinking circle of advisers. “Seizing yachts from oligarchs or making it more difficult for them to drive their Ferraris around London is not going to change Russia’s behaviour,” Glaser says.

Some hope that exclusion from sports events like Wimbledon and the World Cup may have a stronger impact on a sport-loving nation like Russia. But even that will take time. “Football fans understand that this is a consequence of the war,” says Sonin. “But it’s naive to think that this will lead to a revolution. There is no immediate mechanism that will translate this feeling into action.”

For sanctions to make a difference, two things matter most: unity and purpose. Researchers at Drexel University have found that sanctions have been more effective when they aim to promote democracy and defend human rights, whereas destabilising regimes and ending conflicts have been more elusive goals. Notable successes, such as the boycott of South Africa’s apartheid regime, were achieved through consistent enforcement by a coalition of developed economies.

Although the scale of sanctions on Russia is unprecedented, most developing countries – by some estimates representing up to 87 percent of the world population – have refused to toe the line. A case in point is India, which has increased its energy imports from Russia. This has raised concerns that enforcing sanctions is more difficult in a globalised economy, given the rise of alternative trade and financial routes. The ruble has gained ground, courtesy of rising energy prices and dropping imports, while Russia is still earning up to $1bn a day from its oil and gas exports. Experts fear that Russian firms and banks can keep sidestepping sanctions through various backchannels, including a ‘dark fleet’ of tankers transferring oil and grain, under-the-table deals with non-Western banks and digital currencies. Following the annexation of Crimea in 2014, the Russian government took measures to insulate the country’s banking system. But this policy, says Sonin from the University of Chicago, also affects growth: “There is no way Russia’s economy can grow back to 2021 levels until it opens up to international markets.”

Tacit acknowledgment that sanctions have failed to damage Russia’s economy as much as hoped has led to an increased focus on secondary sanctions on non-Russian firms, aiming to unravel the shady network of banks, lawyers and accountants assisting Russian firms to skip sanctions. Following the invasion, five Turkish banks joined the Mir payment system, Russia’s answer to Visa and Mastercard, only to withdraw in September after pressure from the US and the EU. Monitoring compliance can also be problematic due to lack of data and the complexity of international business networks, according to Farnoush Mirmoeini, co-founder of KYC Hub, a UK firm specialising in automated business verification and AML compliance. “Complex corporate structures and use of relatives and associates in financial transactions cause firms to be unable to detect the beneficiary of these transactions,” Mirmoeini says, adding: “Foreign names that are spelled in many different ways in English also enable sanctioned entities to fly under the radar.”

Next stop, China
Despite the central role of sanctions in the global effort to contain Russia, some fear that they could backfire. Coupled with the pandemic, which highlighted the importance of autarky, sanctions could accelerate deglobalisation, as multinationals ‘onshore’ their global supply chains to prioritise security. The war has also brought Russia and China closer, creating an alliance against the West’s dominance of the global financial system. The two countries aim to develop an alternative to the SWIFT interbank messaging system, while Russian banks have started lending in yuan. The collaboration has reinforced fears that China seeks to undermine the dollar’s role as a global reserve currency. “Current sanctions against Russia most likely reconfirm and accelerate China’s desire to create independent and alternative financial channels to those that currently dominate the global financial system,” says Douglas Rediker, a foreign policy expert at Brookings Institute, a US think tank.

The speed and scale of sanctions serve as a cautionary tale for the Chinese government, which has seen its relationship with the US deteriorate over trade disputes and Taiwan. However, using the same playbook on China would be difficult. “Sanctions on China’s exports would likely result in retaliation through China also stopping specific exports to the US, including that of rare earth elements, critical raw materials and more that would devastate the US and world economy,” says Skyler Chi, a global supply chain expert at the US risk management consultancy Exiger. The Asian superpower holds vast dollar-denominated reserves; getting rid of them would send global markets into a tailspin. But given the precedent of the West closing ranks to protect its interests, China has few alternative options, according to Rediker: “China’s economy is not structured to become a major debtor country ready to launch the renminbi as a challenge to the dollar. So they have to accumulate reserves and they have to keep them somewhere.” If anything, the war has proven that a united West still calls the shots, Rediker says: “That common front is probably the most important lesson they have learned, and it will be difficult for them to find an effective response, as long as that cohesion remains.”