By Eric Vandenbroeck and co-workers

Sanctions Can Help End Putin’s Imperial Pretensions If The West Keeps Its Nerve.

However, in his 2022 State of the Union address, delivered less than a week after the invasion of Ukraine, U.S. President Joe Biden touted the “powerful economic sanctions” that the West had imposed on Russia. These measures instantly crushed the ruble and laid waste on the Moscow stock exchange. Russian President Vladimir Putin, Biden warned, “has no idea what’s coming.”

This year, by contrast, Biden did not mention sanctions in his State of the Union speech. His silence was understandable. After edging toward the brink of collapse, Russia’s financial system stabilized. ATM lines dissipated, and the ruble bounced back. The biggest Russian banks lost access to SWIFT, the financial messaging system, and Visa and MasterCard pulled out of the country. But even Western-branded credit cards never stopped working inside Russia. At one point, the International Monetary Fund projected Russia’s economy would contract by 8.5 percent in 2022. Now, it estimates that it shrank by just 2.2 percent.

A year on, it is easy to feel disappointed with the sanctions. Neither the Russian elite nor the Russian public shows signs of breaking with Putin, and the war in Ukraine grinds on with no end. But sanctions are more of a marathon than a sprint, and the long-term picture looks much more promising than the short-term one. Western sanctions have fundamentally altered Russia’s national trajectory by cutting Russia from foreign technology and investment and slashing the Kremlin’s energy revenues. They are destroying the economic model Putin relies on to pursue his imperialist foreign policy.

This dynamic will unlikely change anytime soon, as Putin has boxed himself in. His claim to have annexed four Ukrainian provinces, along with his forces’ crimes against humanity and annihilation of hundreds of billions of dollars of Ukrainian infrastructure, makes it difficult to imagine either side accepting a negotiated settlement that would give Russia relief from sanctions. Putin’s best chance for a reprieve is to rerun his strategy after the West imposed sanctions in 2014 following his annexation of Crimea and initial invasion of the Donbas: a mix of delay tactics and political interference to try to break the West’s will. That means that the fate of the sanctions rests largely in the hands of the United States and Europe. And despite prognostications that they would recoil from confronting Putin, the combination of Ukrainian courage and Russian atrocities has sustained their resolve.

Twelve months of sanctions have shown not only that the West can stay united but also that it is resilient to blowback from sanctions and economic retaliation by Moscow. Just as sanctions have not been as devastating to Russia in the short term as was initially expected, they have not hurt the United States or Europe as much as many feared. Oil prices did not spike. The eurozone did not fall into another financial crisis. European countries learned to make do with less Russian energy. The Kremlin’s retaliation has been muted. The West, it turns out, has far more latitude to use hard-hitting economic weapons against Russia than most Western leaders believed.

In invading Ukraine, Putin sought to restore Russia’s status as a superpower. So long as the West tightens sanctions, that will be impossible.

Last March, Russia’s economic technocrats, led by Elvira Nabiullina, the head of the central bank, saved their country from oblivion and enabled Putin to continue funding the war in Ukraine. Sanctions and export controls on high-tech goods such as semiconductors have squeezed the Russian military’s stocks of precision-guided munitions and other advanced weaponry. Putin has even had to go hat in hand with Iran for military support. But sanctions are neither striking fast enough nor biting deep enough to stop the war. Their role on the battlefield is minor compared with the West’s military assistance to Ukraine. And there is no evidence that they have curbed Putin’s appetite to swallow Ukraine’s territory.

None of this, however, suggests sanctions are not working. That is because the definition of success changed, and rightly so, the day after the invasion. Before February 24, 2022, Biden tried to use the “swift and severe consequences” threat to deter Putin from invading Ukraine. That threat failed. As soon as Russian tanks started barreling toward Kyiv, sanctions could never coax Putin to pull them back. Only Ukraine’s military could do that.

After sanctions failed to deter an invasion, they took on a new objective: blunting Russia’s capacity to do more harm in Ukraine and beyond. Instead of trying to generate enough economic pain to induce a change in government policy, the goal of sanctions against Russia today is now straightforward: economic attrition. The result is that the sanctions against Russia are ambitious in their scope but relatively modest in their aim. And in the more modest objective of sapping Russia’s economic vitality, they are succeeding.

Russia’s economy is big yet simple. The state sells oil and gas and uses the proceeds to field a large military, subsidizing industries like manufacturing that employ millions and fund the salaries of government workers and pensioners. Since the beginning of the war, Russia’s military spending has skyrocketed. Luckily for Putin, energy revenues have remained high enough to keep the economy afloat, mainly because the war boosted commodities prices. The West, worried about surging prices at the pump, was initially reluctant to enact any measures that could pinch Russia’s oil sales. The West’s costliest error in the sanctions campaign was to wait almost ten months before aggressively targeting Russia’s oil revenues. In 2022, Russia raked in nearly $220 billion from oil exports, a 20 percent increase from the year before.

But outside of the energy sector, Russia’s economy has unraveled. That is because the combination of financial sanctions and export controls has cut off Russia’s access to critical technology. The automotive sector, directly and indirectly, employs more than three million Russians is case in point: its production slumped by nearly 70 percent in 2022, dropping to the lowest level since Soviet times. A similar downturn is evident across Russian manufacturing. As a result, while official unemployment has remained low, millions of Russians have been furloughed and put on other forms of unpaid leave. When factoring in this so-called hidden unemployment, more than 10 percent of Russia’s workforce is probably jobless.

Even Russians who have kept their jobs have seen living standards fall. Real incomes have declined, and consumer demand has plummeted. With access to foreign components crunched, AvtoVAZ, Russia’s largest automaker, started selling vehicles without airbags and antilock brakes. And notwithstanding this precipitous drop in product quality, car prices have risen. In 2014, it may have been an exaggeration to call Russia “a gas station masquerading as a country,” as Senator John McCain did then. But sanctions are making this characterization more accurate by the day.

Dire as it is, this situation might still be tolerable for Putin if he could rely on a steady inflow of petrodollars. Yet sanctions are finally starting to hit Russia where it hurts most: the oil sector. In recent months, the EU has placed an embargo on Russian crude oil and petroleum products, and the G-7 has imposed a price cap on Russian oil, a kind of service providers’ cartel that allows Russian oil cargoes to make use of Western shipping and insurance only if they are sold below a set price.

These moves are stinging. Russia’s flagship brand of crude oil, Urals, is selling at considerable discounts to Brent, the international benchmark crude, which resulted in a 46 percent drop in Moscow’s energy revenues this January compared with the same month last year. Paired with ballooning military expenditures, the fall in oil revenues will limit the Kremlin’s policy flexibility and force it to make complex tradeoffs. Russia’s budget deficit shot up to $25 billion in January. Excluded from international capital markets, the Kremlin cannot borrow to compensate for falling export earnings. Eventually, Moscow may have no choice but to allow the ruble to plunge. Gas stations are reliable businesses. But they cannot thrive if they must sell their product for a fraction of the market price.

The trendlines are grim. Starved of Western investment and cutting-edge oil extraction technology and shut out of the European market, the Russian energy industry’s best days are behind it. According to projections by the International Energy Agency, Russia will forgo more than $1 trillion in oil and gas revenues by 2030, relegating the country to a second-rate energy power. And if Russia is a second-rate energy power, Putin’s political and economic model, much less his imperialist fantasies, no longer makes sense.

Although it has been one year since Putin launched his botched campaign to capture Kyiv, it has been nine years since the war began in February 2014, when Russia’s “little green men” swarmed Crimea. In 2014, as in 2022, the West responded by slapping sanctions against Russia. The penalties of 2014 were weaker than those of 2022, but Russia was less prepared for them. By December 2014, under pressure from sanctions and collapsing oil prices, Russia was on the brink of an uncontrolled financial crisis. Its economy was declining at an annualized rate of more than 10 percent. As they did last year, Russia’s economic technocrats came to the rescue, hiking interest rates and imposing de facto capital controls.

I think what happened next is instructive. Instead of pressing its advantage, the West was terrified at the damage it had wrought. German and French leaders publicly cautioned against increasing pressure on Russia. They hurriedly cobbled together the Minsk agreement in February 2015, which froze the conflict but left the underlying problem of Putin’s imperial ambitions unresolved. By the end of the year, Russia’s economy had regained its footing.

In 2023, the West must not repeat this tragic mistake. The impact of sanctions is never static. Targets adapt. They find workarounds, tap new markets, and build new revenue streams. The only way to keep up the pressure is to strengthen sanctions faster than the target can adapt. Over the last year, Russia’s economy has proved more resilient than expected. The same is true of the global economy. Sanctions that were supposed to rattle markets, such as the G-7 price cap and the EU embargo on Russian oil, barely caused a blip.

Meanwhile, retaliation by the Kremlin has proved meager. In the economic realm, the United States and its allies possess the equivalent of what nuclear theorists call “escalation dominance”—the West has many options to harm Russia’s economy at an acceptable cost. Still, Russia’s options of severe countersanctions would be costlier for Russia than for the West.

All this means the West should not be afraid to tighten the screws. The best place to start is Russia’s oil sector. Over time, price discounts on Russian oil will shrink if the market assesses sanctions have plateaued. Russia remains reliant on G-7 tankers and insurance for a large share of its oil sales, but it may eventually build an oil supply chain that does not rely on the West. While it still has this leverage, the G-7 should progressively lower the price cap until it reaches Russia’s marginal cost of production, which would give the Kremlin an incentive to keep selling oil while precluding its ability to earn a profit. And suppose firms based outside the G-7 undermine the policy. In that case, the West should not hesitate to wield the threat of secondary sanctions—penalties on non-Russian companies buying Russian oil—to keep Putin’s oil revenues as low as possible.

The next place to escalate is the financial sector. Shortly after Putin launched the invasion, the United States hit Russia with several financial sanctions, targeting the Central Bank of Russia, Sberbank, and VTB, the country’s two biggest banks. But seeking to keep energy prices stable, it created broad carve-outs for energy transactions. It did not sanction Gazprombank, the main bank serving Russia’s energy sector and its third largest overall. It also steered clear of imposing financial sanctions on Rosneft, the state-owned oil giant; Sovcomflot, the state-owned shipping firm; and other key companies in Russia’s oil sector.

These decisions were both needlessly cautious and massively beneficial to Putin. The West should impose “full blocking sanctions” on all the major firms involved in Russia’s oil trade, which would sever their access to the Western financial system. It should also narrow the energy carve-out to allow Russia to use its petrodollars only to buy humanitarian goods such as food and medicine. The West should stand ready to use secondary sanctions against foreign banks that help Russia use its oil proceeds to buy weapons, industrial components, and other goods that have no humanitarian value.  

The Biden administration has signaled its willingness to use secondary sanctions against firms that aid Putin’s war effort. It has also emphasized efforts to check sanctions evasion. These are good ideas, but they do not go nearly far enough. If the West focuses its sanctions campaign in 2023 on merely enforcing penalties it enacted in 2022, Russia’s economy will continue to recover.

Economic strength is the foundation of military might. Over the past two decades, Putin remade Russia into a formidable military power thanks to flourishing connections to the global economy and soaring oil profits. Now, sanctions have a chance to reverse that. They alone will not end the war in Ukraine. But if the West keeps its nerve, sanctions can help end Putin’s imperial pretensions.

 

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