Economic sanctions are policies designed to hurt the economy of a target country. Sanctions can involve trade embargoes, seizure of assets, travel bans and limits on capital flows.
The aim of sanctions is usually to provide a political signal of disapproval which stop short of military action. They can be imposed by one country unilaterally, but are more effective if they can be applied multilaterally by many countries. Sanctions have been imposed by the United Nations, the US and EU in a variety of cases, some more successful than others.
Sanctions aim to put pressure on the target country to change their behaviour, but in some cases can encourage the country to find new ways around the sanctions (such as increasing domestic production). Sanctions also impose economic costs on the country which levied them.
Examples of economic sanctions
- Limit access to capital. Capital countries can prevent countries from borrowing money on international markets, making it harder to finance government debt.
- Banning foreign direct investment. The US has prohibited US companies from being involved in trade with Iran or investing in Iran.
- Seizing assets. Individuals associated with a particular regime can have their foreign assets seized or frozen. For example, a form of sanctions on Russia has been asset freezing of individuals associated with the Putin regime. It means their foreign bank accounts can be frozen and certain individuals lose money and assets they hold abroad.
- Removing banks from SWIFT international payments. A crucial sanction on Russia 2022 was freezing the Russian Central Bank and other banks from the SWIFT international payments system. This means that although the Russian Central Bank has around $640 billion of foreign currency reserves, it will not be able to access them. This has important implications as the Central bank will not be able to provide liquidity to other Russian banks who need to provide foreign cash to depositors. Previously Central Banks like Iran, North Korea and Venezuela has been affected.
- Trade sanctions. This involves banning trade from a target country, limiting their ability to export goods. This may be limited to particular industries, such as arms sales or maybe more wide ranging. For example, in Feb 2022 UK imposed restrictions on trade and export controls against Russia’s hi-tech and strategic industries.
- Trade embargoes. A trade embargo is a much more wide-ranging ban on trade. The US has imposed embargoes (with varying degrees of support from other countries) on South Africa, Cuba, Iran, Iraq and North Korea, making it hard for these countries to export their goods.
Impact of Economic sanctions
Economic sanctions will impose various economic costs on the target country depending on the magnitude and extent of the sanctions. Likely effects include.
1. Devaluation in the exchange rate. With limits on capital and export, there will be less demand for the country’s exchange rate. Also if sanctions are widespread it will reduce confidence about holding assets in the target countries. This can lead to a significant fall in the exchange rate. For example, in 2022, after the imposition of economic sanctions on Russia, the Russian Rouble fell 10% within a few days to an all-time low of $1 = 86.3 Roubles (24 Feb) A fall in the exchange rate will increase the cost of imports and increase the cost of living.
2. Inflationary pressures. Sanctions are likely to cause higher inflation for a few reasons A devaluation in the exchange rate will lead to higher price of imported goods. If the sanctions lead to a shortage of goods and services, it can cause upward pressure on prices.
3. Fall in Assets. A wide-ranging package of sanctions will reduce value of target countries, assets, such as shares, bonds and asset prices. Russian stock markets fell by 33% on the day of the Ukraine invasion – partly due to the instability, and also the imposition of sanctions. In Feb 2022, President Biden announced financial sanctions against Russian banks and against Russia’s sovereign debt, which meant Russia is not able to secure western financing of its debt. This is likely to lead to higher interest rates on debt and could lead to inflationary pressures if the Russian government responds to liquidity shortages by printing money.
4. Higher interest rates. In response to higher inflation, the Central Bank may be forced to raise interest rates. Also, if the target country has less access to fund sovereign debt, this will push up interest rates on government bonds to attract domestic buyers to purchase the bonds.
5. Negative Impact on trade. Trade embargoes will hit exports. For example, Iran a major oil producer struggled to export oil after being hit with economic sanctions. This led to lower economic growth as the economy cannot gain revenue from its key industry. An important factor is whether the sanctions are universal or piecemeal. For example, the US and EU are imposing sanctions on Russian exports of gas and oil, but a key question is whether Russia is able to find new export buyers, such as China? If China agrees to buy gas from Russia, then it will limit the effectiveness of EU sanctions and the cancelling of the Nord Stream 2 from Russia to Germany.
6. Fall in living standards. Effective sanctions can seriously reduce the wealth of an economy, leading to higher prices, a shortage of key goods and a rise in unemployment. The concern is whether the fall in living standards targets the political rulers or the poorest in society. For example, from 1990 Iraq faced prolonged universal sanctions, imposed by United Nations Council Resolution 661. The sanctions were very effective because the Iraq economy was heavily dependent on oil exports. It led to widespread economic disruption and reports of widespread poverty and malnutrition. The sanctions were considered by some to be a humanitarian disaster, and the sanctions seemed to hurt the poorest in society whilst leaving the ruling party untouched. To deal with this the sanctions were slightly revised in 1995, with an “Oil for food program” aimed to enable a modest sale of oil in return for food.
7. Diversification in response to sanctions. Iran has faced prolonged sanctions, such as barriers in the sale of oil and access to capital markets. In 2006, oil exports accounted for 85% of Iran’s exports. By 2010-11 this had fallen to 78.9% In response to sanctions, Iran has tried to respond to sanctions by diversifying the economy and encouraging domestic industrialisation as a way to replace imports. It has called this the ‘resistance economy’ and it also seeks ways around the sanctions by using third-party companies and countries. It is also sought to use barter trade. Zimbabwe also engaged in similar practises when it attempted to promote its own domestic industrialisation in response to sanctions.
8. Black market. One unintended consequence of sanctions is that it can encourage the black market has imports are smuggled into the country. Some observers claim this can actually increase the power of the regime because successful smuggling requires the cooperation of authorities (an issue in Iran). The problem is that the black market often causes some to become rich and powerful while ordinary people struggle to get basic necessities.
9. Decrease in foreign direct investment. Foreign direct investment will fall both due to the direct impact of sanctions but also because of the reputational costs associated with the sanctions as companies will become reluctant to be associated with the targetted country.
Impact of sanctions on those who impose sanctions
Higher prices. When sanctions are imposed on a target country there will be an invariable cost on the countries who impose them. For example, the EU’s sanctions on Russian oil and gas will push up prices for EU customers. With prices already high due to supply constraints, a significant long-term rise in prices could become politically unsustainable in the west. One study (Hufbauer, 2008) found that if sanctions on Iran were dropped, the increase in supply from Iran could reduce oil prices by 10%, saving the US $76 billion at 2008 world oil prices of $100 bb.
- However, in the long-term, a shortage of oil and gas from countries like Russia and Iran could lead to different energy policies from the West. It increases the incentive to produce more gas through controversial policies like fracking. It may also increase the incentive to move to energy sources like wind, solar and nuclear which do not have the geopolitical tensions of gas and oil imports.
Loss of credit. If a country is excluded from international capital markets and excluded from the Swift international payments system, then the target country loses access, but it will also hit creditor countries. For example, banks in France, Italy and Austria have lent Russia an estimated $30bn which they might never regain if financial sanctions last.
Effectiveness of sanctions – case studies
- Sanctions against South Africa are widely considered to be successful in forcing the country to give up its apartheid policies. The sanctions were widespread and significantly isolated South Africa.
- Sanctions against Sadam Hussein’s Iraq caused fall in GDP and social issues, but on its own did nothing to weaken the regime or change their policies.
- Sanctions on North Korea have driven them closer to China and failed to change the regime.
- Limited sanctions on Russia from 2014 did nothing to change behaviour of Putin and Russia was able to absorb the limited scope of the sanctions.
- The United States’ selective sanctions against China (up to 2004) had no “significant adverse effect” on its economy (“US Economic Sanctions against China: Who Gets Hurt?” World Economy” Yang et al. 2004),
- The 2011–2014 sanctions against Iran decreased Iran’s GDP by 17 percent (Gharehgozli 2017);
- The impact of financial sanctions on the Russian economy 2014-2017 has led to an estimated negative effect on gross capital flows of approximately $280bn. Though the net capital flow losses is lowers at $165bn, due to Russian companies’ self-adjustement. Gurvich (2015)
- Counter-measures by Russia to sanctions by EU, led to decrease in Baltic states GDP by 0.4 – 0.8% (Veebel and Markus 2018, 15–16).
- Decreasing access to financing, and possible overall economic shocks, increases the likelihood of banking crises (especially under financial and costlier sanctions) (Hatipoglu and Peksen 2018).
- Consequences of economic sanctions at International Studies Review