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February 27, 2015

Russia Under Sanctions: It's Not Working

Writing about web page http://www.ft.com/cms/s/0/92c75076-b606-11e4-a577-00144feab7de.html

On the evening of Tuesday 24 February I joined a panel discussion on "Russia Now," organized by Warwick Arts Centre's Mead Gallery. My fellow panellists were Peter Ferdinand (Politics and International Studies) and Christoph Mick and Christopher Read (History). The discussion was chaired by Mead Gallery director Sarah Shalgosky, whom I thank for the invitation. Here's what I said, roughly speaking.

Sanctions in history

The Russian economy is subject to Western sanctions. These sanctions are of two kinds. There are "smart" sanctions that aim to limit the international travel and transactions of named persons and corporations. There are also broader sanctions that aim to limit the international trade and borrowing of Russia’s financial, energy, and defence sectors.

In history, advocates of economic sanctions against an adversary have usually claimed two advantages for them. One claimed advantage is speed of action: It has often been predicted that economic sanctions will quickly "starve out" an adversary (metaphorically or literally). The other claimed advantage is cost: By attacking the adversary’s economy we can achieve our goals without the heavy casualties to our own side that would result from a military confrontation.

Are these claims justified by experience? Based on the experience of modern warfare and economic sanctions from the Napoleonic Wars through the U.S. Civil War and the two World Wars of the twentieth century to the Cold War, Rhodesia, South Africa, and Cuba, the answer has typically been: "No."

How do sanctions work?

The effects of sanctions on national power have generally been slower and smaller than expected. First, they attack national power indirectly, through the economy, and the economy provides a very complicated and uncertain transmission mechanism. If a country is refused access to something for which it appears to have a vital need, such as oil or food, it generally turns out that there are plenty of alternatives and ways around; nothing is as essential as it seems at first sight. Secondly, external measures will be met by counter-measures. In a country that is blockaded or sanctioned, soldiers will look for ways to use military strength to break ouit and so offset economic weakness. Suffering hardship and feeling unfairly victimized, civilians will become more willing to tighten their belts and fight on.

It would be wrong to go to the other extreme and conclude that sanctions achieve nothing. What have sanctions actually achieved in historical experience? Sanctions do raise the cost of producing national power. They do so gradually, so that immediate effects may not be perceptible. Nonetheless they impose costs on the adversary, and eventually these costs will tell. It is hard to show, however, that sanctions have ever had a decisive effect on their own; at best, they have been shown to have their effect in combination with other factors, such as military force. In those cases, sanctions were a complement to military power, not a substitute or alternative.

Russia: How are Western sanctions supposed to work?

The purpose of Western sanctions is clear: It is to change President Putin’s behaviour, making him more cautious and more accommodating to the demands of Western powers.

What is the mechanism that is supposed to bring this about? Western observers generally see that President Putin's political base is built on the use of energy profits to buy political support. Russia's energy sector, much of it state-owned, has provided major revenues to the Russian government budget. The Russian government uses these revenues to buy support, partly by paying off key persons, partly by subsidizing employment in Russia's inefficient, uncompetitive domestic industries. The result is that many people feel obligated to Putin's regime because without it they would lose their privilege or position in society.

In that context, sanctions have been designed to target those industries and persons that supply resources to the government and those that depend on the government for financial support. By doing so, they aim to deprive President Putin of the resources he needs to retain loyalty.

How have sanctions actually worked? In Russia, real output is falling and inflation is rising. It is important to bear in mind, however, that in recent months sanctions have been only one of three external sources of pressure on the Russian economy.

Three pressures on Russia's economy

Three factors have been at work: sanctions, confidence in the ruble, and energy prices. These factors should be thought of as semi-independent: there are obvious connections among them, but in each case the agency is different.

  • Sanctions. Before the crisis over Crimea, Russian corporations had approximately $650 billion of short-term, low-interest debt denominated in foreign currency. International lenders have reluctant to lend to Russia long term because Russia's lack of protection of property rights leaves them uncertain about the security of their loans. Because this debt is short term, it requires regular refinancing. Russian firms, including organizations and sectors that have not been directly targeted by sanctions, are now unable to borrow abroad. Struggling to cover their credit needs, they have turned to the Russian government to make emergency loans or bail them out.
  • Confidence in the ruble. As lenders have lost confidence in Russia, capital flight has increased. The ruble has lost half its external value in the last year, and this has doubled the real burden of private foreign currency debts of Russian corporations and also wealthy families with housing debts in euros or dollars. This has intensified private sector pressure on the government for bail-outs.
  • Oil prices. The dollar price of oil has halved since this time last year, slashing Russia's energy revenues and plunging the state budget into deficit.

These three pressures all point in the same direction and complement each other. Their cumulative effect is to be seen in the deteriorating outlook for the economy as a whole and for public finance. The government has lost important revenues while spending pressures have multiplied. Arguably, therefore, sanctions have "worked," because they have squeezed the capacity of the Russian administration to satisfy the expectations of its supporters.

A learning opportunity

From a social-science perspective, we should think of this moment as a learning opportunity: How the Russian administration responds in these circumstances should reveal its type.

To benchmark the Russian response today, consider how two Soviet leaders responded to closely similar situations in the past.

  • One benchmark is offered by Mikhail Gorbachev in 1985. By the mid-1980s the global energy market had reached a situation not far removed from that of today. A decade of high oil prices was being brought to an end by new non-OPEC suppliers. This put the Soviet economy under a severe squeeze. Faced with this squeeze, Mikhail Gorbachev chose policies of demilitarization and relaxation abroad and at home.
  • Another benchmark is offered by Joseph Stalin in 1930. If anything, the predicament of the Soviet economy in 1930 was even closer to its situation today. Soviet exports were faced with collapsing prices as the world economy entered the Great Depression. The Soviet economy also had considerable short-term debts that suddenly could not be rolled over because international lending dried up. In response, Stalin demanded "the first five year plan in four years!" This involved accelerated mobilization and sacrifice, and ended in the famine deaths of millions of his own citizens (many of them in Ukraine).

These examples illustrate the alternative responses of a ruler under external pressure. When it becomes harder to buy loyalty the ruler can respond like Gorbachev, by moderating demands on supporters; or like Stalin, by cracking the whip over them. In 2015, faced with economic sanctions, falling oil prices, and a falling ruble, which choice has President Putin made? His words and deeds both deserve attention.

  • Before sanctions, President Putin's words were of a Russia encircled by enemies and penetrated by foreign agents. His policies involved accelerated rearmament and frozen conflicts with Moldova and Georgia, capped by the annexation of Crimea.
  • How did things change after Western sanctions were imposed? Putin's rhetoric shifted up a notch with talk of national traitors and a "fifth column" of enemies within. His economists began to discuss ways to shift from a market economy to a "mobilization economy." His foreign policy spokesmen incited tensions in the Baltic region and made nuclear threats against the West. The Russian military embarked on continuous large-scale exercises and increased the frequency of testing NATO defences in the Baltic and the North Sea. Russian forces and heavy weapons were infiltrated into Eastern Ukraine.

The lesson for social science is that under external economic pressure President Putin has revealed his type: He is a power-building authoritarian ruler.

It isn't working

From a policy perspective, the effect of sanctions on the Russian economy is only the tactical outcome of sanctions. Their strategic purpose is to change Russia's behaviour for the better, and that is the only true test of whether they have worked. The lesson for policy is that, despite sanctions, President Putin remains prepared to take risks with peace and to commit aggression. Sanctions are not changing his behaviour.

Now we know this, what should we conclude? A clear implication is that things could get worse. Some worry (or threaten) that, if the pressure on him grows, President Putin might became more confrontational and take additional risks rather than back down and look for compromise. It has also been suggested that, if unseated, Putin might be replaced by someone worse -- a role for which there are several candidates.

Why isn't it working?

This leads to me to a sombre conclusion. It's not a conclusion that I much like; I have thought about it a lot and I wish I could see another way out of the situation. To sum it up, I'll quote in full a letter that I wrote to the Financial Times recently in response to an article by Gideon Rachman ("Russian hearts, minds, and refrigerators," February 16). My letter appeared on 19 February:

Gideon Rachman ... writes : “Rather than engage the Putin government where it is relatively strong, on the battlefield, it makes more sense to hit Russia at its weak point: the economy.” But this neglects the incentives that arise from the time factor.

If the West plays to its strength, which is economic, President Putin will play to Russia’s strength, which is military. But the action of Western financial and trade measures is slow and cannot be accelerated. Meanwhile, Russia can accelerate its military action at will.

In playing the sanctions card while neglecting defence, the West is encouraging President Putin to raise the tempo on the battlefield and change realities quickly and irrevocably through warfare, before the Russian economy can be weakened further.

For the West, therefore, economic sanctions are not an alternative to a military confrontation that is already under way. To avoid disaster, the West must support financial and trade measures with a credible defence.


February 18, 2015

Russia's Improbable Futures and the Lure of the Past

Writing about web page http://rbctv.rbc.ru/polls/list

On 27 January I was asked to join a panel on Russia's Future within the University of Warwick One World Week. (The other panel members were Richard Connolly, co-director of the University of Birmingham Centre for Russian, European, and Eurasian Studies, and the journalist Oliver Bullough.) I decided to talk about how Russians are looking to the past in order to understand their uncertain future. Here, roughly, is what I said:

Russia has many possible futures; all of them are improbable. The economy must do better, stay the same, or do worse. Relations with the West must improve, remain as they are, or deteriorate further. Adding them up, there are nine possible combinations. The probability of any particular combination is small, so each is improbable. But one of them must happen because, taken together, the sum of the probabilities is one. One of them must happen, but we have no idea which one.

Faced with an uncertain future, we often look to the past for guidance and reassurance. What was the outcome when we were previously in a situation that felt the same? At New Year, many Russians were looking to the past. I found this out when I stumbled on the website of RBC-TV, a Russian business television channel. Every day the RBC website polls its fans on a different multiple-choice question. On 30 December, the question of the day, with answers (and votes in parentheses), was:

What should Father Frost bring for Russia?

  • End of sanctions (6%)
  • End of the war in Ukraine (27%)
  • A stable ruble (7%)
  • Return of the Soviet Union (59%)

It's disconcerting to be reminded of the strength of nostalgia among Russians for the time when their country was a global superpower. The Soviet Union united all the Russias -- if anyone's not sure what that means, that's Great Russia, Little Russia and New Russia (Ukraine), and White Russia (Belarus) -- with the countries of the Baltic, Transcaucasia, and Central Asia. The Soviet Union stood for strong centralized rule, with a powerful secret police and thermonuclear weapons. The nostalgia is shared by President Putin, who said (on 25 April 2005): “The collapse of the USSR was the greatest geopolitical disaster of the [twentieth] century.”

Here's a question that RBC asked its supporters on 25 December:

Can direct controls and a price freeze save Russia’s economy?

  • Yes, the free market is not up to the job (55%)
  • No, that would cause insecurity and panic (40%)
  • No need – no crisis (5%)

Again, the strength of support for the backward-looking answer is disconcerting. I tried to think of the last time the Russian economy was in a squeeze like today's. The last time the oil price price came down like this was the mid-1980s when North Sea and Alaskan oil broke the power of the OPEC cartel for a few years (that's the analysis of Anatole Kaletsky). The disappearance of oil rents probably contributed to the collapse of the Soviet economy.

But a closer parallel to today is 1930, when two things happened at once. The global market for Soviet exports shrank in the Great Depression. And international lending dried up, meaning that the Soviet economy could not roll over its debts. The Soviet import capacity collapsed almost overnight. Stalin responded by forcing the pace of import substitution through rapid industrialization. He demanded "The five plan in four years!" The result was a crisis of excessive mobilization that claimed millions of lives in the famine of 1932 and 1933.

Prominent in calling for an economic breakthrough today is President Putin, who responded to Western sanctions on 18 September 2014: “In the next 18 to 24 months we need to make a real breakthrough in making the Russian real sector more competitive, something that in the past would have taken us years.” Government-friendly Russian economists are talking about the need to go from a market economy back to a mobilization economy. In case the foreigners aren't getting the message, first deputy prime minister Shuvalov told those assembled in Davos on 23 January: “We will survive any hardship in the country – eat less food, use less electricity.”

A third question that RBC asked its viewers was on 19 December:

What matters most for the country right now?

  • The foreign exchange rate (33%)
  • Who is a true patriot and who is fifth column (56%)
  • “Vyatskii kvas” (11%)

(The English equivalent of "Vyatskii kvas" would probably be Devon cider. For the reasons why it was being talked up as a solution to Russia's problems last December, click here.)

Here the strength of support for the backward looking answer is shocking. What is the "fifth column" and how does it resonate in Russian history? In 1937, Stalin saw Moscow surrounded and penetrated by enemies. This coincided with the siege of Madrid in Spain’s Civil War. In 1936 the nationalist General Mola was asked which of his four columns would take Madrid. He replied, famously: “My fifth column” (of undercover nationalist agents already in the city). In Madrid the Republicans responded by executing 4,000 nationalist sympathisers. In the Soviet Union Stalin, who was also watching, ordered the execution of 700,000 “enemies of the people.”

In recent times, the spectre of a "fifth column" was first reawakened by President Putin on 18 March 2014, when he remarked: "Western politicians are already threatening us with not just sanctions but also the prospect of increasingly serious problems on the domestic front. I would like to know what it is they have in mind exactly: action by a fifth column, this disparate bunch of ‘national traitors’, or are they hoping to put us in a worsening social and economic situation so as to provoke public discontent?"

Putin took up this theme again on 18 December 2014: "The line that separates opposition activists from the fifth column is hard to see from the outside. What’s the difference? Opposition activists may be very harsh in their criticism, but at the end of the day they are defending the interests of the motherland. And the fifth column is those who serve the interests of other countries, and who are only tools for others’ political goals."

Here you can see that Putin did affirm the possibility that opposition can be loyal. But is it possible for Russia to have a loyal opposition today? The only example of loyal opposition that Putin could bring himself to mention was the poet Lermontov -- who died in 1841.

These echoes of the Soviet past in Russian opinion today are disconcerting and even frightening. At the same time it is important to remember that, even while Russians look to the past, Russia today is absolutely not the Soviet Union. From today's vantage point it is nearly impossible to imagine how closed, stifling, claustrophobic, and isolated was everyday life even in late Soviet times. Russians in 2015 lead very different lives from Soviet citizens in 1985. They are richer, live longer, are able to visit, study, phone, and write abroad. Even today they are relatively free to search for and find information and discuss it among themselves. In all these ways, the transition from communism has not been a failure.

As Andrei Shleifer and Daniel Treisman (2014) wrote recently: "Putin’s authoritarian turn clearly makes Russia more dangerous. But it does not, thus far, make the country politically abnormal. In fact, on a plot of different states’ Polity [i.e. democracy] scores against their incomes, Russia still deviates only slightly from the overall pattern. For a country with Russia’s national income, the predicted Polity score [a measure of democracy] in 2013 was 76 on the 100-point scale. Russia’s actual score was 70, on a par with Sri Lanka and Venezuela."

To see Russia as just another middle income country helps us to identify Russia's underlying problem. In Russia, just like in Sri Lanka, Venezuela, and most countries outside “the West,” wealth and power are fused in a small, closed elite, and that is how it has always been. The fusion of wealth and power was and remains normal. Before the revolution Russia was governed by a landowning Tsar, aristocracy, and church. After the revolution Russia was governed by a communist elite that monopolized all productive property plus media, science, and education. Today Russia is governed by an ex-communist, ex-KGB elite that has once again gathered control of energy resources and the media. This fusion of wealth and power is neither new nor is it unusual among middle and low income countries.

In societies where wealth and power are fused, particular people are powerful because they control wealth and the same people are wealthy if and only if they are powerful. This is what gives politics in such societies its life-and-death immediacy. To lose power means to lose everything; when power change hands there is often violence. “All politics is real politics," write Douglas North, John Wallis, and Barry Weingast (2009); "people risk death when they make political mistakes.”

Several times in history, liberal reformers have tried to separate wealth and power in Russia and make space for public opinion. Here are some examples from the last 150 years:

  • In 1864 a reform brought elected local governments – but within an absolute monarchy.
  • Shaken by military defeats and popular insurrections, in 1906 the Russian monarchy introduced an elected parliament, although with few powers, and ndividual peasant landownership, although (as it turned out) with little time for implementation.
  • In 1992 and 1995 Russia saw voucher privatization and "loans-for-shares," creating a class of corporate shareholders – but the outcome was crony capitalism, not free enterprise.
  • In 2003, Mikhail Khodorkovskii tried to separate the governance of Yukos from the "power vertical," but he went to prison for it.

All these efforts have so far achieved only partial or temporary success. Russia has not yet found a solution to the problem of the fusion of wealth and power. Here, at last, is an aspect of Russia's future that is certain: If Russia is ever to find a solution to this problem, it will be there.

Note: I updated this column after publication to correct a date -- 2014, which appeared as 1914.

References

  • North, Douglas, John Wallis, and Barry Weingast. 2009. Violence and Social Orders A Conceptual Framework for Interpreting Recorded Human History. Cambridge: Cambridge University Press.
  • Shleifer, Andrei, and Daniel Triesman. 2014. "Normal Countries: The East 25 Years after Communism." Foreign Affairs, November-December.

March 13, 2014

Stay Where You Are: Russia Will Come to You

Writing about web page http://www.forbes.com/sites/paulroderickgregory/2014/03/10/putins-big-lie-on-ukraine-if-it-werent-so-serious-it-would-be-funny/

An old joke has resurfaced in connection with Ukraine's Crimean crisis. I saw it first in a column by my co-author Paul Gregory:

You want to live in France? Go to France. You want to live in Britain? Go to Britain. You want to live in Russia? Stay where you are: Russia will come to you.

It's generally hard to work out when and where such jokes originated, but this one has real-life foundation.

Before the war Menachem Begin, who was later Israel's prime minister, was a Jewish activist in Poland. When Germany and the Soviet Union divided Poland in 1939 he fled to Lithuania, where Soviet troops arrived in 1940. With thousands of others, Begin was arrested. He was accused of being a British agent under Article 58 of the RSFSR (Russian republic) criminal code, which dealt with counter-revolutionary crimes. In a later memoir Begin recalled a prison conversation (Weiner and Rahi-Tamm 2012, p. 14):

When Begin inquired how article 58 of the Soviet Criminal Code (counter revolutionary activity, treason, and diversion) could be applied to activities that were considered legal in then sovereign Poland, his interrogator did not hesitate: “Ah, you are a strange fellow [chudak], Menachem Wolfovich. Article 58 applies to everyone in the world. Do you hear? In the whole world. The only question is when he will get to us or we to him.”

This raises an interesting question: If the jokes are the same, is the system the same? In other words, is Putin's Russia the same as Stalin's Soviet Union? In most aspects of everyday life the answer is: Clearly not. In Russia today there is far more freedom of speech, assocation, and enterprise than there ever was in the Soviet Union. But there is also much less of these things than there should be. And there are disturbing continuities with the Soviet past in Putin's KGB background and loyalty, his nostalgia for the Soviet empire, and the identification of national power with his personal regime.

Directly linked to these things is continuity in Russia's menacing approach to its neighbours. The people of what was once eastern Poland (now western Ukraine and western Belarus), and Lithuania, Latvia, and Estonia, are being reminded today that they live in territories to which "Russia came" in 1939 and 1940. These occupations were followed by unanimous parliamentary votes and rigged referenda, the registration of the population and issuing of "passports" (ID cards), and mass arrests and deportations.

If we are returning to the past, one may hope for a new era of Russian jokes. Unfortunately, it may turn out that the best jokes have already been told.

Reference

Weiner, Amir, and Aigi Rahi-Tamm. 2012. Getting to Know You: The Soviet Surveillance System, 1939-1957. Kritika 3:1, pp. 5-45.


I am a professor in the Department of Economics at the University of Warwick. I am also a research associate of Warwick’s Centre on Competitive Advantage in the Global Economy, and of the Centre for Russian, European, and Eurasian Studies at the University of Birmingham. My research is on Russian and international economic history; I am interested in economic aspects of bureaucracy, dictatorship, defence, and warfare. My most recent book is One Day We Will Live Without Fear: Everyday Lives Under the Soviet Police State (Hoover Institution Press, 2016).



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