The Economic Impact of Sanctions against Russia on EU Member States

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While attending a workshop on international sanctions a few weeks ago, I was fortunate to meet the author of the fascinating and very recent article “The Redistributive Impact of Restrictive Measures on EU Members: Winners and Losers from Imposing Sanctions on Russia“. Much has been written on EU-Russia relations following the crisis over Ukraine and important obstacles to a rapprochement remain; however, there have been few other detailed assessments of the economic impact of the sanctions, countersanctions and geo-political uncertainty on EU member states. Because the magnitude of the overall economic effects was a surprise to me – trade contracted by over a third for almost all EU member states and by much more for some members since 2013 – I couldn’t resist to take a brief look at the changes in the EU-Russia trade relationship myself: my analysis below complements the cited work but is based on more fine-grained data, which offers a potentially more nuanced assessment of some aspects of the development in EU-Russia trade relations.

“The concerns expressed by several EU leaders regarding the cost of the restrictive measures imposed on Russia were justified.” (p. 15)

In response to the annexation of Crimea by the Russian Federation in March 2014 and Russia’s support of armed separatist forces in eastern Ukraine, a group of states, led by the European Union and the United States, has imposed separate but overlapping sanctions on Russian individuals and businesses. EU sanctions have repeatedly been broadened in scope and today include restrictions against proponents and beneficiaries of Russian actions in Ukraine, economic sanctions against state-owned banks, energy and defence companies, as well as limitations on economic exchanges with Crimea. On 13 March 2017, the European Council prolonged the restrictive measures for a further six months, until 15 September 2017.

Sanctions are an important part of the policy response to what the EU and the US consider illegal actions by the Russian government. Germany has particularly emphasised the importance of a political solution and has strenuously worked towards a negotiated settlement: in March 2015, EU leaders decided to align the existing economic sanctions to the complete implementation of the Minsk II agreement, a package of measures to de-escalate the military confrontation in the Donbas that Germany and France facilitated between Moscow and Kiev. The provision of economic aid and military capabilities to Ukraine has been another pillar of the Western response; Germany has mostly focused on financial contributions.

This brief assessment aims at quantifying the changes in the EU-Russia trade relationship – which reflect economic sanctions and countersanctions as well as other factors, such as investor uncertainty and considerable changes in the exchange rate. The article also provides evidence on which member states have been affected the most in their trade relations with Russia and whether there are countries or sectors with excessive export losses or gains. This becomes especially relevant with regard to present discussions over burden-sharing and demands for a compensatory mechanism on the European level, as well as the Russian countersanctions on agricultural products, which may place disproportionately higher costs on the Southern and Eastern European countries.

In Sections 1 and 2, the text provides some background on the rationale behind the introduction of economic sanctions against Russia. This will then be complemented in Section 3 by a quantitative analysis of EU-Russia trade flows since 2013.

1. Cost-Benefit Analysis of Sanctions

Policymakers do not necessarily use economic sanctions because they think they are the most effective technique of statecraft; they use them because they are more cost-effective. (Baldwin 1999, 101) As one of the world’s largest economies and military heavyweights, Russia is not an obvious target for economic pressure, let alone military intervention. While the EU has used sanctions as a response to deteriorations in other country’s democratic institutions and rule of law, Russia was long considered a ‘strategic partner’. The crisis over Ukraine which in the eyes of many observers led to a fundamental transformation of Europe’s security landscape has, however, shifted the cost-benefit calculus of European governments – and for some faster than for others.

The volatile situation left EU members sufficiently concerned about Russian ambitions to accept the direct economic losses from sanctions, costs from retaliatory actions (the Russian countersanctions) and foregone cooperation in other areas. Despite some initial reluctance, Germany played a key role in convincing member states to unanimously agree to multiple rounds of sanctions. The most significant trigger event was the downing of flight MH17 over Ukraine which stiffened the EU’s resolve to hold Russia accountable, particularly in Germany. (Kundnani 2015, 114) In this regard, sanctions enable the sender to “avoid creating negative images of itself” (Baldwin 1999, 101) because it decides to actively address a perceived injustice.

Partial trade suspensions are generally adopted either as part of a calculated strategy to signal the potential of still worse pain to come if the target fails to comply or as a second-best measure because more pressing domestic or international political constraints rule out comprehensive pressure. (Pape 1997, 94) While the successive build-up of sanctions suggests the former, economic interdependence between European countries and Russia makes the latter the more accurate description of the situation. Most notably, EU sanctions have been carefully crafted to, at least theoretically, share the economic burden across all member states and exclude existing energy sector ties because numerous members depend heavily on Russian gas supplies. (The sanctions do, however, impose restrictions on the transfer of technologies for more advanced offshore and Arctic projects that could provide the Russian government with funds in the future.)

2. Intentions behind the Sanctions against Russia

Sanctions are employed against Russia for three purposes: as a signal to domestic and international audiences that the West is willing to enforce respect for international law, as a means to induce conformist behaviour and reverse territorial aggression, and as a punishment for those responsible for the aggression. (Although the general motive of ‘punishment’ by sanctions is sometimes disputed in the literature.) Overall, the US response is perceived as more retaliatory than European sanctions, which are more explicitly tied to de-escalatory steps and require unanimity to renew every few months.

Restrictive measures are targeted at key decision-makers and entities that are of significant strategic importance for the Russian state; the “smart” design of sanctions tries to avoid alienating the Russian population. However, this does not mean that the sanction’s ultimate goal is regime change, as some pundits have suggested. (Pond 2015) Given the size of the Russian economy, limited economic sanctions would hardly make a difference when aiming for a high salience goal like regime change. Instead, they intend to raise the financial burden on the Russian government, which has to recapitalize affected banks and companies, and thereby alter its political cost-benefit calculation on Ukraine.

The real impact of sanctions is notoriously difficult to assess. Analysts’ opinions range from „Western policymakers got lucky” because sanctions coincided with the collapse of oil prices, thus worsening, but not causing, Russia’s economic decline (Ashford 2016), to “if it had not been for economic sanctions, Putin would have seized Odessa” (Navalny 2015). But in the political realm, sanctions might have proven counterproductive: while the literature suggests that sanctions hurt personalist dictatorships like Russia (Geddes 2014a, 14; 2014b, 317) most because they limit the state’s capacity to provide gains though patronage and compensate for losses (Escribà-Folch/Wright 2015), the regime was able to blame Western sanctions for Russia’s deepening recession. In this respect, sanctions and Russian countersanctions on agricultural products have had – at least in the short term – a ‘rally-around-the-flag’-effect which boosted Putin’s approval rating to 88 percent by October 2015. (Ashford 2016, 120) Some analysts also suggest that instead of shifting the balance of power within Russia, Putin’s inner circle actually became stronger because the Kremlin has shielded those with connections to the ruling circle, thereby shifting the burden to those without such ties. (Ashford 2016, 120)

The following section will explore the changes in the EU-Russia trade relationship and will especially look at the costs of sanctions to the EU member states.

3. Quantitative Changes in the EU-Russia Trade Relationship Since 2013

The EU-Russia trade relationship has transformed significantly over the last few years and especially since the introduction of restrictive measures by the EU and other international actors. On the aggregate level, EU exports to Russia dropped considerably from €119 billion in 2013 to €73 billion in 2015, but seem to have stabilised in 2016 with around €72 billion. The analysis below is based on data collected by Eurostat and describes export flows on the Harmonized System (HS) 2-digit product specification level. Each observation depicts the trade value in an HS-2 product category for an individual EU member state and for each full year from 2012 to 2016.

As can be expected, the export volume of individual EU member states varies considerably and, respectively, there is a similar variation in the total change in exports to Russia – although all EU members saw their exports decrease considerably. Figure 1 shows goods exports by country and year; it also suggests that the export volume stabilised again in 2016 but remains on a significantly lower level compared with 2013. Overall, German companies seem to have borne the brunt of the reduction in exports with an overall decrease of about 14 billion Euro, followed by Italian (losses of €4 bn), Dutch (decrease of €3.3 bn), Polish (minus €2.9 bn) and French (minus €2.8 bn) exporters. Figure 2 summarises the overall changes in exports between 2013 and 2016. A brief look at the exports of Eastern European countries does not suggest that their losses were disproportionately high in comparison to other EU member states; this will be investigated further below.

Figure 1 – Exports to Russia by Country and Year

ExportsByEUMemberState

Source: own calculation based on Eurostat data

Figure 2 – Overall Change in Exports 2013-2016 by Country

LossesByEUMemberState

Source: own calculation based on Eurostat data

But what about the magnitude of the effects relative to each member states’ trade volume? I calculated the percentage change in exports between 2013 and 2016 for each HS-2 product category and EU member state. While the percentage change in exports per product category varies, the figure below shows considerable losses for all member states in many and for almost all EU countries in the large majority of – HS-2 product categories. As shown in the boxplot below, the median change across product categories is negative for all member states and for many the trade volume in more than 75 percent of all product groups decreased. However, there remain a few product groups with significant increases in trade volume for all countries and the graph even omits a few extreme percentage values which are the result of very low trade volumes in 2013.

Figure 3 – Variation of the Change in Exports in Percent (by HS2-Product-Category)

VariationByProductGroupAndEUMemberState

Source: own calculation based on Eurostat data

However, most observations (product categories) that recorded a significant percentage increase actually do not entail a large total trade volume. Figure 4 confirms that for most observations, growth is actually limited to two-digit percentage values and, in particular, that for most categories with extreme increases, the real trade volume is actually relatively small – note that the x-axis uses a logarithmic scale and also depicts the 2016, i.e., resulting trade volume!

Figure 4 – Percentage Change in Export Volume

PercentageChangeByHS-2-Product-Group

Source: own calculation based on Eurostat data

Because of the natural clustering of exports in important HS-product categories (cf. Figure 8 in the annex), overall export losses are primarily due to significant decreases in important product categories like pharmaceuticals (group 30), plastics (group 39), machinery and electrical equipment (groups 84 and 85), and motor vehicles (group 87). The figure below shows the total decrease in exports for individual HS-2 categories by total trade volume in the particular category in 2016. This highlights that there are some product categories with previously very large trade volumes that have been affected considerably by the uncertainty since 2013. Note that the x-axis is logged, which makes the decreases in exports look somewhat less severe than they really were. The figure identifies the respective exporter country for all observations with a trade volume above €0.75 billion or a decrease of more than €200 million.

Figure 5 – Total Change in Export Volume

TotalChangeByProductGroup

Source: own calculation based on Eurostat data

Noteworthy in Figure 5 are, of course, the extreme values for Germany in the bottom right as well as similar losses for the Netherlands and Italy a little further to the left. The largest decreases can generally be observed in product groups 84, 85 and 87 –categories with particularly large trade volumes (cf. Figure 8 in the annex, which shows the clustering of exports across product groups). German exports are affected the most when it comes to total numbers, followed closely by Italy and the Netherlands. There are five observations with losses over one billion Euro:

Table 1 – The five largest Decreases in Trade Volume (by HS-2 category)

Country HS-2 Product Group Change in Exports (in million Euro)
Germany 84 (machinery) -4110.487
Germany 87 (motor vehicles) -3914.380
Italy 84 (machinery) -1260.995
Netherlands 84 (machinery) -1263.531
Germany 85 (electrical equipment) -1185.483

In comparison, the 10 largest increases in trade volume are summarised in Table 2. Please note, however, that especially the first extreme value of an increase of UK exports in one product category by €361 million might be due to a coding error in the original Eurostat dataset (the value for 2013 is 0 in 2013).

Table 2 – The 10 largest Increases in Trade Volume (by HS-2 category)

Country HS-2 Product Group Change in Exports (in million Euro)
United Kingdom 88 361.2589
Germany 99 255.66148
Poland 89 135.78375
Sweden 30 108.84965
Netherlands 30 102.31174
Lithuania 30 101.4235
Poland 88 92.75015
Belgium 24 78.23774
United Kingdom 97 75.14608
Netherlands 94 68.5481

A heatmap can shed more light on the differences between member states: to increase readability, all increases in trade volume that exceed 100 percent are coded as 101 percent in the heatmap below. Figure 6 is a standard heatmeap that is based on the percentage changes in product categories between 2013 and 2016 and does not employ any ordering/clustering technique. It shows that there are generally few product groups that were affected equally across all member states, although exports in some categories certainly decreased more significant than others. All empty (white) fields indicate no exports in this category.

Figure 6 – Percentage Change in Export Volume

Heatmap1Unsorted

Source: own calculation based on Eurostat data

This can be complemented by a grouped heatmap based on the total export values. The standard clustering technique closely mirrors the findings above by placing Germany in its own category as well as identifying the Netherlands and Italy as two countries that were similarly affected. In terms of product categories, the clustering also highlights the importance of the categories 84, 85 and 87 which were all introduced above. (Note that both columns and rows have been re-ordered.)

Figure 7 – Total Change in Export Volume

Heatmap2Sorted

Source: own calculation based on Eurostat data

Finally, let’s take a look at which member state lost the most in terms of their own trade volume. What becomes quickly evident is that Germany, Italy and the Netherlands, while losing considerably in actual exports, are not the countries where trade contracted the most. Instead, this happened in some of the smaller member states such as Malta, with a staggering decrease by 91 percent, Cyprus, Denmark, and Austria – all countries where exports decreased by more than 50 percent. These findings, together with potential intra-country variations, could support calls for a compensatory mechanisms on the European level. However, it has to be kept in mind that it is difficult to differentiate the economic effects that are directly related to the restrictive measures and those economic losses that are due to the general uncertainty in diplomatic relations. This assessment, of course, only looked at the general picture and did not try to identify losses that are directly connected to the sanctions – which would require to look specifically at the decisions of export licensing bodies in EU nation states.

Interestingly, the exports of Eastern European countries do not seem to have suffered more from the sanctions and uncertainty than the exports of other EU members. In fact, most Eastern European countries generally seem to be at the lower end of the spectrum, with Romania and Latvia accounting for the lowest relative decreases of about 29 percent each – only Luxembourg’s exports were affected less. It would be interesting to see whether this is due to geographic proximity or rather to other factors, such as a different composition of exports. The same question could, of course, also be asked about changes in Russian exports to Europe. In light of the Russian countersanctions on agricultural products, it would also be important to look at the relative decreases across product categories, i.e., did exports in foodstuffs drop more significantly than exports in other categories? (Figure 8 already points to some differences.) These could be questions for a second post.

The statistical analysis shows that the exports of EU member states to Russia dropped significantly following Russia’s aggression against Ukraine. Overall, exports to Russia decreased by around €47 bn between 2013 and 2016. Almost all member states were affected considerably, with exports decreasing between 2013 and 2016 by over a third for all but three countries and by significantly more for some. However, it also has to be kept in mind that most EU members’ export dependence on the Russian market is actually relatively low (dependence on imports of Russian oil and gas remains generally much higher), so export losses might not have affected European companies quite as much as the figures suggest. This factor might also have allowed EU governments to renew the sanctions against Russia repeatedly over the last years despite the sometimes sharp criticism from some national or corporate interest groups.

Table 3 – Relative Change in Exports between 2013 and 2016

Country Exports 2013 (in Euro bn) Exports 2016 (in Euro bn) Percentage Change
CYPRUS 0.0242155 0.0101777 -57.97
MALTA 0.0355991 0.0031534 -91.14
LUXEMBOURG 0.1513321 0.1229588 -18.75
PORTUGAL 0.2630461 0.1430563 -45.62
CROATIA 0.2821922 0.1905628 -32.47
GREECE 0.4045786 0.2154911 -46.74
BULGARIA 0.5828675 0.3440287 -40.98
IRELAND 0.6323035 0.3610700 -42.90
SLOVENIA 1.1899501 0.7896050 -33.64
ESTONIA 1.4114699 0.7760442 -45.02
DENMARK 1.5458647 0.7106047 -54.03
ROMANIA 1.3820157 0.9696565 -29.84
LATVIA 1.7595057 1.2432260 -29.34
HUNGARY 2.4929693 1.3997160 -43.85
SLOVAKIA 2.5547578 1.4774592 -42.17
SWEDEN 2.6566448 1.4954250 -43.71
SPAIN 2.8128835 1.6027393 -43.02
AUSTRIA 4.2350732 1.9085688 -54.93
CZECH REPUBLIC 4.4678082 2.7641994 -38.13
LITHUANIA 4.8690204 3.0490700 -37.38
UNITED KINGDOM 4.6489663 3.0365940 -34.68
BELGIUM 5.1131902 3.2765809 -35.92
FINLAND 5.1734384 2.8487580 -44.93
NETHERLANDS 7.8397351 4.5648140 -41.77
FRANCE 7.6834994 4.8926282 -36.32
POLAND 8.1128247 5.2067950 -35.82
ITALY 10.7475278 6.7012670 -37.65
GERMANY 35.7891781 21.6654552 -39.46

 

4. Annex & Bibliography

Figure 8 depicts the natural clustering of exports in certain important HS-2 categories, such as product group 84 (machinery) or 87 (motor vehicles).

Figure 8 – Clustering of Exports to Russia across HS-2 Product Categories

ExportsByHS2-Product-CategoryAndYear

Source: own calculation based on Eurostat data

Bibliography

Ashford, E. (2016): Not-So-Smart Sanctions. The Failure of Western Restrictions Against Russia, in: Foreign Affairs 95, 1 (January-February 2016), 114-123

Baldwin, David A. (1999): The Sanctions Debate and the Logic of Choice, International Security 24 (3), 80-107

Escribà-Folch, A. / Wright, J. (2015): Foreign Pressure and Autocratic Survival, Oxford: Oxford University Press (chapter 3)

Geddes, B. / Wright, J. / Frantz, E. (2014a): Autocratic Regimes Code Book. Version 1.2; online: https://journals.cambridge.org/action/displaySuppMaterial?cupCode=1&type=4&jid=PPS&volumeId=12&issueId=02&aid=9297187

Geddes, B. / Wright, J. / Frantz, E. (2014b): Autocratic Breakdown and Regime Transitions: A New Data Set, in: Perspectives on Politics 12 (2), 313-331

Kundnani, H. (2015): Leaving the West Behind. Germany Looks East, in: Foreign Affairs 94 (1), 108-116

Navalny, A. (2015): An interview with Kremlin critic Alexei Navalny, in: Washington Post; online:  http://www.washingtonpost.com/blogs/worldviews/wp/2015/03/18/a-rare-interview-with-kremlin-critic-alexei-navalny/

Pape, R. A. (1997): Why Economic Sanctions Do Not Work, in: International Security 22, 2, 90–136

Pond, E. (2015): Germany’s Real Role in the Ukraine Crisis. Caught Between East and West, in: Foreign Affairs 94 (2)

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The Economic Impact of Sanctions against Russia on EU Member States