The Sanctions Weapon

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Not since the 1930s has an economy the size of Russia’s been placed under such a wide array of commercial restrictions as those imposed in response to its invasion of Ukraine.
Russia is the world’s 11th largest economy and, unlike Italy and Japan in the 1930s, is a major exporter of oil, grain, and other key commodities, making sanctions on it a qualitatively different global shock.
The sanctions regime discussed was imposed by 38 North American, European, and Asian governments and combines legal, commercial, financial, and technological restrictions that drastically impede Russia’s access to the world economy.
The combination of: (a) wartime disruption of Ukrainian trade (closure of Black Sea ports) and (b) sweeping sanctions on Russia has produced a uniquely powerful economic shock; additional sanctions on Russian oil and gas exports would magnify these effects further.

Global food prices rose 28 percent in 2020 and 23 percent in 2021, and they surged 17 percent this year between February and March alone.
Russia’s and Ukraine’s disrupted exports include wheat, corn, sunflower oil, and other goods.
Russia’s trade openness: trade-to-GDP ratio of 46 percent (World Bank data).
Among the seven largest emerging markets, only Mexico and Turkey had higher trade-to-GDP shares in 2020: 78 percent and 61 percent.
Historical precedents: the League of Nations sanctions on Italy (after October 1935) were implemented by 52 of the roughly 60 sovereign states at that time.
Impact of 1930s measures on Italy: industrial production fell by 21.2 percent from October 1935 to June 1936; exports plummeted by 47 percent in the first five months of sanctions before stabilizing at roughly two-thirds of their pre-sanctions level.
Japan’s trade fell by 20 to 25 percent in just 18 months in the late 1930s–early 1940s as embargoes and asset freezes tightened.

Greater global integration: higher trade-to-GDP ratio today and a highly integrated dollar-based global financial system.
Unlike the 1930s (deflationary world, fragmented currency blocs, diminished trade), today’s world faces strong inflation pressure and nodal vulnerabilities in commodity, financial, and technology flows.
Modern sanctions can cause larger global commercial losses but are more susceptible to trade diversion and evasion.
Sanctions now generate spillovers through higher commodity prices, higher transaction costs, larger supply bottlenecks, and greater trade losses—affecting more people worldwide.
Sanctions against a top-stratum economy like Russia place acute pressure on net-commodity-importing emerging market and developing economies, increasing their risk of balance of payments crises and explaining why many such countries have not joined the sanctions.

Advanced economies should focus on long-term infrastructure investment to ease supply chain pressures.
Emerging market and developing economies should prioritize income support for vulnerable populations.
Advanced economy central banks should avoid rapidly tightening monetary policy to prevent capital flight from emerging markets.
Looming debt and balance of payments problems in developing economies can be tackled through debt restructuring and increases in their allotments of the IMF’s Special Drawing Rights, a type of international reserve currency.
Humanitarian relief should be extended to distressed economies, especially in the form of food and medicine.
The world’s major economic blocs should better organize their demand for food and energy to reduce price pressures caused by hoarding and competitive overbidding.

Greater financial and trade integration reduces the probability of full deglobalization but increases the scale of spillovers from sanctions on large economies.
Modern sanctions lower the direct risk of military escalation relative to the 1930s but widen avenues for nonmilitary retaliation (economic and technological).
The use of fiscal and monetary tools to compensate for sanctions’ global stress is ultimately a political choice; advanced economies have more fiscal space and policy tools than in the early 20th century.
Without coordinated policy adjustments in the next few months, grave concerns about the world economic outlook for 2022 and beyond will be justified.

F&D Magazine — The Sanctions Weapon — Nicholas Mulder — June 2022