Trade sanctions, financial sanctions, asset freezes, and travel bans are some of the current favourites in the toolbox of foreign policy. They are meant to hurt the target country's economy through artificial frictions on the movement of goods, capital, and people. They promise a tailored response with the possibility of fine-tuning and a quick return to normal. Sanctions come at a cost, however – often overlooked or downplayed – on private actors in the sender countries' economies (e.g. Hufbauer et al. 2009). In this column, we report findings from recent research on the impact of the sanctions and countersanctions between 37 countries and Russia in response to the simmering conflict in Ukraine, started in 2014 (Crozet and Hinz 2016). Following the Russian involvement in separatist movements in eastern Ukraine and the annexation of Crimea, these 37 countries levied sanctions on Russia starting in March of 2014. The measures were intensified in July 2014. Russia then retaliated by imposing an embargo on certain food and agricultural products. The strength of the pre-sanction economic ties and the number of sanctioning countries (which totalled roughly 55% of world GDP in 2014) make this episode unprecedented and particularly instructive.
The big picture: Global impact of sanctions and counter-sanctions
We first gauge the overall global impact of the conflict and sanctions that started in late 2013 and continue to be in place in June 2016. Broadly speaking, the episode can be broken down into three periods:
- A conflict period in which tensions started to grow between December 2013 and February 2014;
- A period of "smart sanctions" starting in March 2014; and
- A third period, starting in August 2014 with the implementation of economic sanctions in the form of trade restrictions and financial sanctions, and Russian counteraction in the form of an embargo on certain food and agricultural products
We estimate the impact of the three different periods on exports of embargoed and non-embargoed products in a structural gravity framework. Using monthly export data from UN Comtrade, we estimate the general equilibrium effects of the conflict, smart sanctions, and trade and financial sanctions. Our model predicts all bilateral flows in the absence of the respective sanctions and captures accurately the sudden changes in Russian import capacities due to collapsing oil prices and devaluation of the rouble. The difference between the predicted and the observed flows amounts to the lost trade.
Between December 2013 and June 2015, global losses totalled $60.2 billion, on average $3.2 billion per month. As Figure 1 shows, the composition of these losses is very heterogeneous. EU member states bear 76.7% of all lost trade and 78.1% of non-embargoed one. Even among geopolitical heavyweights the burden is drastically unequal. Germany is bearing 27% of the global lost trade, while France accounts for 5.6%, the UK 4.1%, and the US just 0.4%. Particularly noteworthy is that 83% of this lost trade can be considered collateral damage, being exports of non-embargoed products or of embargoed products before the actual implementation of the Russian counter-sanctions.
Figure 1. Monthly absolute trade losses (in million US dollars per month)
Firm-level analysis: Why are non-embargoed products affected?
To understand the mechanisms at play at the firm level, we estimate the effect of the sanctions regime on French firms using detailed monthly customs data. Next to the overall impact, we explore the mechanisms behind the large drop in exports of non-embargoed products.
Unsurprisingly, both extensive and intensive margins took a major hit in response to the sanctions. The probability of a given firm exporting to Russia decreased by 8.2% in the period from December 2013 to February 2014, before the actual implementation of sanctions. This deteriorated further until July 2014 to reach 9% in an environment of growing anxiety and initial smart sanctions, i.e. asset freezes and travel bans on Russian officials. In August 2014, with the implementation of economic sanctions from both sides, the export probability dropped by 14.1%. While the export participation of firms exporting embargoed products dropped by 77%, even those exporting non-embargoed products decreased by 12%. On the intensive margin the effects were, as expected, also most severe for embargoed products, with a decline of 49% since the beginning of the economic sanctions. However, again we find a significant decrease in exports of products that were not embargoed of 7%.
Figure 2. Number of French firm-level export flows to Russia and control group destinations
While the decrease in exports of embargoed products is no big surprise, we investigate why those products that were not directly targeted by any policy were also significantly impacted. We explore three different mechanisms through which these non-embargoed products could be affected by the measures in place. Contrary to current research on boycotts (Heilmann 2016), a possible shift in consumer preferences cannot explain the decrease in exports of French products to the Russian Federation. Products that are highly identifiable as being French by branding were not affected differently than others. Similarly, the exporting firms' perceived country risk did not contribute to the downturn. The literature on firm dynamics has emphasised firm size and length of experience as determinants for persistence in tougher times. In contrast, we find larger firms and those with higher pre-conflict sales in Russia to be more adversely affected by the sanctions. Instead, we find the results to be consistent with a trade finance mechanism. As financial sanctions have partly disrupted financial relationships between Russia and sanctioning countries, it is very plausible that affected financial institutions were no longer able to provide attractive trade finance services. The existing literature on trade finance highlights the particularities of exported goods using utilising these services. Only select headings take advantage of trade finance instruments, in turn on average being exceptionally large shipments (Niepmann et al. 2015, Demir et al. 2014). When interacting an indicator for letter of credit-financed trade with the incidence of the sanctions, we find a significantly stronger effect of the sanctions for those export flows that use trade finance services intensively. This result indicates that financial sanctions contributed significantly to the drop in exports of those goods that were not directly targeted by trade restrictions.
(Almost) no trade diversion
Finally, we find that the French firms that were affected by the sanctions were by and large not able to recover their losses by shifting their exports to other destinations. Contrary to research showing that firms in sanction-targeted economies massively divert their sales to other markets (Haidar 2014), we find that only a fraction of the losses are recovered. Firms that are directly exposed to the embargo exported on average 24% less than comparable firms. Firms that were exposed to the Russian market before but were not exporting embargoed products saw a decrease of 12% in their total exports. Their respective total exported quantities decreased less than that, suggesting lower sales prices in the fraction of trade that was indeed diverted to other markets.
Crozet, M. and J. Hinz (2016). "Collateral Damage: The impact of the Russia sanctions on sanctioning countries' exports". CEPII Working Paper No. 2016-16.
Demir, B. and B. Javorcik (2014, September). "Grin and Bear It: Producer-financed Exports from an Emerging Market". CEPR Discussion Paper 10142.
Haidar, J. I. (2014). "Sanctions and export deflection: Evidence from Iran". Mimeo.
Heilmann, K. (2016). "Does political conflict hurt trade? Evidence from consumer boycotts". Journal of International Economics 99(C), 179–191.
Hufbauer, G. C., J. J. Schott, and K. A. Elliott (2009). Economic Sanctions Reconsidered, 3rd Edition (paper). Number 4129 in Peterson Institute Press: All Books. Peterson Institute for International Economics.
Niepmann, F. and T. Schmidt-Eisenlohr (2015, November). "International Trade Risk and the Role of Banks" International Finance Discussion Papers 1151, Board of Governors of the Federal Reserve System (U.S.).