The Biden administration has warned Russia that military intervention in Ukraine would be met with strong economic sanctions—not simply the blocking of Russia's gas exports through the new Nord Stream 2 pipeline but also stringent export controls denying Russia access to high technology goods from the United States and other countries. Such measures certainly would go far beyond those deployed after Russia annexed Crimea eight years ago and inflict serious economic pain. Yet these measures may still not be enough to deter Russia from military action against Ukraine.
The measures under consideration would also go beyond those covered by the Defending Ukraine Sovereignty Act (DUSA), introduced in the Senate in mid-January. Aside from blocking Nord Stream 2, the legislation would ban financial transactions with major Russian banks covering sovereign debt and ban participation in Russia's extractive industries (oil, gas, coal, minerals). The legislation would also exclude Russian financial institutions from the Society for Worldwide Interbank Financial Telecommunication (SWIFT), the global cooperative that facilitates international financial transactions. It would also call for adding senior political and military officials to the US Treasury's list of Specially Designated Nationals (SDN) and Blocked Persons that subjects those named to asset seizures and visa restrictions.
Another even more potent sanction would be the use of US export and re-export controls on advanced semiconductors and other high technology goods, akin to recently imposed controls targeting Chinese firms. The Biden administration recently briefed US high-technology companies on the possibility of using the foreign direct product (FDP) rule of the US Export Administration Regulations to restrict US and foreign exports to Russia of goods made with US equipment or containing sensitive US components.
Broader embargoes on Russian energy exports presumably are omitted from the list because they would cause major economic disruptions to European markets as well. The Russian economy would suffer from even a partial decoupling of ties with the West, but comprehensive sanctions against Russia also would hit European economies far more than US producers and consumers. The European Union's trade and investment with Russia is substantially greater than US commercial ties with Russia: EU merchandise trade with Russia is eight times greater than US trade, and EU foreign direct investment (FDI) in Russia is almost 25 times greater than US FDI. US and EU officials likely will calibrate their restrictions to temper collateral damage to their own economies.
2014 sanctions had only a minor economic impact on the Russian economy
Does Putin take the threat of sanctions seriously enough to deter him from pursuing Russia's territorial ambitions?
The lesson of Russia's actions eight years ago is instructive. Soon after Russia invaded Ukraine in February 2014, US officials imposed a series of sanctions designed to punish high level government officials and weaken the Russian economy through restrictions on trade and finance with Russian energy companies and specified banks, in the hope that these measures would deter further military advances in Ukraine and neighboring countries. Additional measures, coordinated with European allies, were added in July and September 2014 but stopped short of the measures imposed against Iran that had earlier isolated the target country from most channels of international trade and finance.
The sanctions had only a minor economic impact on the Russian economy, did little to dislodge Russia from Crimea and eastern Ukraine, and—as now seems evident—only temporarily deterred Putin's territorial ambitions. Targeting Putin's inner circle seems to have had little effect on its members' behavior or support for Russian policy. Too often, those targeted simply moved their assets out of the reach of US officials, suffered little from travel restrictions, and were amply rewarded by the Russian government. Sanctions complicated the pace of development of energy resources but have not prevented Russia from maintaining its high levels of oil and gas production and continuing to sell large volumes of natural gas to Europe through a series of pipelines.
Over the past eight years, Putin has taken additional measures to protect his country by deepening Europe's dependence on Russian gas, opening new gas export markets in China, and developing a new financial messaging platform, the System for Transfer of Financial Messages, to compensate for the potential expulsion from SWIFT.
What impact would new sanctions have?
One measure that is much speculated on in the press would involve naming President Vladimir Putin and his senior government and military officials to the US SDN list. It is highly unlikely that any of them have foreign assets that could be seized by Western authorities or are planning vacations in Florida or the French Riviera. But such action would ostracize Russia further as a pariah state.
As for targeting Russian financial institutions, several Russian banks could be blacklisted by the US Treasury, transactions involving new Russian sovereign debt issuances prohibited, and some entities blocked from access to SWIFT. These restrictions would make financing in Russia more costly and cumbersome for both domestic and international transactions. Sanctions to decouple major Russian banks from international markets will hurt affected customers and shareholders, but the systemic impact would be small compared to taking similar action against China's top banks, the largest in the world. And important Russian firms will surely still have access to finance from the Russian government.
As discussed in a previous blog post, blocking the opening of the Nord Stream 2 pipeline would deprive Gazprom and Russian tax collectors of substantial revenues, assuming that Russian exports are not rerouted through other pipelines. However, Gazprom had windfall profits from its 2021 gas exports so could easily absorb the temporary loss of export earnings. European countries could manage the loss of the expected additional volumes of Nord Stream 2 gas through increased imports of liquefied natural gas from the United States and Qatar, and temporarily reverting to coal and nuclear. The main risk of blocking Nord Stream 2 is Russian countersanctions that would cut off the flow of gas through existing pipelines. Substantial reductions in Russian gas deliveries to Europe would be hard to replace in the near term.
Using the foreign direct product (FDP) rule of the US Export Administration Regulations (EAR) to apply US export controls in overseas markets is potentially the most intrusive and damaging sanction that is likely to be introduced. The FDP rule effectively extends US export controls to foreign firms that do business with those on the US Commerce Department entities list. Those firms require US re-export licenses to trade products or software and other technologies subject to the EAR, or those products made using US equipment or US-origin software or technology. The FDP rule would have a clear impact on semiconductors and products made with US high-tech machinery.
The broader the coverage of the FDP rule, the greater the potential damage to the Russian economy. Restrictions targeting specific firms would have a narrower impact than those affecting sectors of the economy or all of Russia. However, the effectiveness of the extraterritorial US controls requires foreign firms and governments to cooperate in enforcing them. The broader the scope of US export controls, the greater the difficulty in securing compliance by Russia's trading partners. US officials are likely to find it easier to secure, albeit grudgingly, cooperation from US allies in Europe and East Asia. But getting China to accept and enforce US controls that interdict shipments to Russia is unlikely and could trigger punitive measures required by China's new anti-foreign sanctions law against firms in China that comply with US export controls. For these reasons, US officials may opt for more narrowly targeted measures that focus on sectors with military or cyber applications.
The Biden administration has been conducting elaborate negotiations with allies over all these steps, guaranteeing that they would leak out. Whether the discussion will discourage Russia from invading or steel Russian resolve may be soon evident.
1. DUSA is the Democratic alternative to a Republican-backed bill that was voted down in the Senate on January 13 because of concerns that its focus on killing the Nord Stream 2 gas pipeline would create friction within the transatlantic alliance.
2. At the end of 2019, EU FDI in Russia was valued at more than $350 billion on a historical cost basis compared to $14.4 billion in US direct investments.