02.12.22 Sanctions Review

The Race of Restrictions: sanctions may not critically damage a large economy, but they may permanently undermine its technological competitiveness potential

Economic sanctions are effective against small economies, while large ones can resist and retaliate against them. Therefore, in the confrontation with autocracies, primarily with Russia and China, Western countries should rely on the imposition and strict control of technological sanctions, according to Geneva Center for Security Policy experts. This would undermine the development of their military and economic potential and deprive them of the opportunity to increase their global political influence. Such a scenario, however, largely involves abandoning the globalization goals and returning to the practices and institutions of the Cold War. For this reason, the friendshoring concept expressed by the United States Treasury Secretary Janet Yellen — building trade and production chains mainly with countries that share the values of democracy — has caused a heated debate among economists: there is no clear answer to the question of how exactly a return to Cold War practices will affect the non-democratic camp in the long term.
The notion of the low efficiency of Western sanctions against Russia has become commonplace and was confirmed by economic statistics. For example, according to the latest Rosstat figures, in October 2022, the volume of output by basic types of economic activity (an indicator closest to GDP) decreased by 4.2% compared to October 2021, which is approximately half or even three times less than the forecasts of spring 2022. However, many economists consider the "optimistic" conclusions about the sanctions' effect to be premature (in a special Re: Russia report we have talked about how international sanctions work and do not work, and what this means for Russia). At a recent conference in Washington, IMF experts presented a theoretical model of the sanctions' impact, showing that even though sanctions inevitably hit the party that imposes them, the losses of the sanctioned side turn out to be substantially greater.

Another review of sanctions against Russia by the Geneva Centre for Security Policy Studies (GCSP) shows that their use against large economies does not lead to many expected effects, but has severe long-term consequences, ensuring its technological gap and the loss of its competitive position on global markets.

In the past two decades, sanctions were mostly imposed on small countries or regional powers whose exclusion from the global economy did not entail strong negative consequences for the global markets. Now, for the first time in history, large-scale sanctions have been imposed against large and deeply integrated global world economies. This experience allows us to conclude that large countries, such as Russia and China, are more resilient to economic sanctions. 

First, the success of Western restrictions against smaller economies was attributed to the fact that banks around the world use the European SWIFT system, and the main currency for international payments is the dollar. However, large economies can create their own payment systems and use national currencies for settlements with partners. At the same time, control over compliance with banking restrictions falls on the banking systems of the countries imposing sanctions (the GCSP report states that the costs of compliance with restrictive requirements for the United States and Canadian banks alone will total about $56.7 billion in 2022).

Second, unlike smaller countries, large economies can impose retaliatory restrictions (counter-sanctions) that are tangible both for those who wanted to punish them and for the rest of the world. An example is Russia's energy war against Europe. Third, sanctions against major businesses of large economies are fraught with unpredictable negative consequences (as an example, the GCSP report cites sanctions against RUSAL and the Chinese state shipping company COSCO, which caused disruptions in global commodity markets). Forth, big countries have a wide range of partners, some of which will continue to trade and cooperate with the sanctioned country in some way, significantly weakening the sanctions' effect.

Although, according to the GCSP report, the sanctions remain quite effective, their main impact looks different. While sanctions cannot undermine the current functioning of a major economy, they can significantly slow down the development of its economic and military potential, determining its further irreparable lag in the technological race and competitiveness. Such restrictions will be effective not only against Russia but against China as well, whose ability to withstand the conventional sanctions' effect is even greater than Russia's. 

Technological sanctions cause significant damage to the Russian and Chinese economies, although in the short term this does not affect their GDP. For example, the suspension of Taiwanese manufacturer TSMC's cooperation with Russian business has called into question the fate of domestic Elbrus and Baikal processors, and Russian credit institutions have to reuse the chips in bank cards now. Difficulties have arisen not only in civilian but also in the military sectors. For example, RAND believes that the crash of six military aircraft in Russia in autumn was caused by a lack of necessary Western spare parts and equipment, the import of which became impossible due to the sanctions.

China needs advanced Western chips to win the race on artificial intelligence creation, which opens the door to technological dominance in the 21st century. In October 2022, the Joe Biden administration imposed an export ban on super-powerful chips for artificial intelligence, equipment for their production, and some semiconductor technologies to China. Moreover, Washington's restrictions affected not only chips made in the United States, but all the chips manufactured with the use of American technologies. A week later, the United States imposed restrictions on the employment of its citizens in Chinese chip factories.

GCSP experts note that in addition to the high-tech products and technologies supply ban, it is necessary to introduce mechanisms for effective control of such restrictions. The Wassenaar Arrangement, concluded in 1996 between 33 countries, which includes Russia, does not constitute such a mechanism. Therefore, a possible solution could be to revive the Coordinating Committee for Multilateral Export Controls (CoCOM), which used to compile lists of "strategic" goods and technologies that could not be exported to the Eastern bloc countries during the Cold War and ceased operations after the USSR collapsed. 

However, the strategy of technological restrictions and the sanctions imposed by the United States against China has become the subject of heated controversy. Danny Rodrik of Harvard, a well-known expert on emerging economies, sees it as a mistake: China will perceive such sanctions as an "aggressive escalation" and look for a way to strike back, the mutual distrust and market tensions will only escalate and cause returned damage to Western economies. Former Swedish Prime Minister Carl Bildt believes that the Biden administration's decision undermines the principles of free trade and gives an advantage to China, which will continue to pursue an aggressive trade policy and build bilateral trade and economic relations with many countries, which will ultimately increase its political influence in the world. On the contrary, Russian economist Sergei Guriev of Sciences Po believes that the "friendshoring" concept promoted by Janet Yellen, the United States Treasury Secretary, which involves building trade and production chains mostly with friendly countries, has significant prospects and greater economic justification than is commonly believed. In her opinion, reducing dependence on trade with autocracies will allow Western countries to better withstand the threats posed by non-democratic countries and, will help to preserve the principles of free trade that undermine authoritarianism in the long run.