How to increase the effectiveness of sanctions against Russia

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BrusselsReport.eu
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By Volodimir Dubrovskiy. 

The author is a senior economist at CASE Ukraine, where he is responsible for research and publications in the fields of macroeconomics, political economy of transition and private sector development. Prior to this position, he was a consultant to the Harvard Institute of International Development (HIID)/CASE Ukraine Macroeconomic Reform Program (1997-2000). He is one of the authors of tax reform projects in Ukraine.

Can Ukraine win?

Relying on its own strength, as some hotheads urge – definitely not, even if it becomes the like of the Russian Federation (which would be a defeat in itself) or a new Israel (which is impossible). The forces are too unequal: besides being four times superior in population, Russia was economically ten times stronger before the full-scale war. This year alone, it has directly or indirectly budgeted 14.7 trillion rubles for the war, roughly the size of Ukraine’s GDP without the help of partners. The key to Ukraine’s victory therefore lies in the West: the Ramstein coalition outweighs the Russian Federation economically by a factor of 30. Figuratively speaking, a cat, no matter how fighting, cannot beat a huge rabid mad dog, but if an elephant stands up for it, then the dog has no chance. A problem, however, is that the elephant is a peace-loving and clumsy creature… In particular, the West still produces too little ammunition, is in no hurry to increase capacity, and categorically doesn’t want to get into a fight – it’s a rabid dog after all…

Understanding this simple arithmetic, some less hot heads are beginning to call for negotiations and “peace“. But it takes two to tango. Putin, who has declared the destruction of Ukraine his goal, does not need negotiations that do not lead to its surrender. Besides, this war is really existential, as he says, only not for Russia, which in one form or another was, is and will be, but for his mafia-like regime in which Akela is not allowed to miss up. Therefore, even sacrificing territory (in itself unacceptable) would bring neither peace nor even a reprieve: the ceasefire would be broken as soon as Putin saw that Ukraine was making better use of the reprieve than he was.

There is, however, a solution. But that is on another plane: victory for Ukraine and sustainable peace are tantamount to the collapse of Putin’s regime. And the latter is a perfectly achievable goal, at least more realistic than a purely military victory. Moreover, even if it were possible to expel the enemy from our territory, the war would not end there. In the meantime, a combination of properly structured sanctions and military failures (which require continued and increased military support for Ukraine, but all that can be said about that has already been said) is fully capable of destroying the Kremlin regime. And it is in this combination.

But “sanctions don’t work”? Yes, not as we would like them to – for three reasons.

First, most of them are not aimed at breaking up the regime, but only at creating certain difficulties in obtaining parts needed for military production, as well as inconveniencing some Russians, etc. This is largely successful, but of course it does not lead to victory.

Second, when it comes to more serious sanctions, economists usually focus on limiting growth (or better yet, recession), balance of payments, i.e. devaluation of the ruble, and other measures that could undermine welfare, but that wouldn’t happen immediately either. But, for one thing, Russians are not the people who will sell their imperial ambitions for lentil stew: real welfare fell more than GDP in 2022, and that did not affect ratings. On the other hand, Putin is going all out to quell discontent: the regime’s repressiveness has already far surpassed the late Soviet regime, and this is far from the limit. And there are no mechanisms for this discontent to translate into political change, food riots are in light-years .

Finally, third, the West simply does not have the political will to destroy the criminal regime. In other words, it is not yet ready to win the war, although it is moving in that direction.

The power vertical is actually a very fragile structure. It is based on expectations that are fulfilled: as long as its members believe that “the mafia is immortal”, it is immortal; and the boss’s orders are obeyed as long as they believe that he will remain in power tomorrow. If there is reason to doubt that tomorrow someone will be punished for disobedience or rewarded for loyalty, such a vertical is breaking down, even though it seems “the powers that be are stronger than ever,” as we saw in Ukraine in late 2004, early 2014, and the older generation in the late 1980s.

The Achilles heel of the mafia regime is the rent on which it rests. In Russia, this has traditionally been oil export revenues (gas plays a lesser role): the official part alone forms about a third of the federal budget, which is 8-9 trillion rubles. Of course, it is not possible to stop these exports while China and India have them in the world, but by capping prices, it is quite possible to make it bring in only a minimum revenues. Even if this doesn’t ruin the economy (which is mostly market-based and therefore very resilient), depriving it of oil rents in the absence of external borrowing opportunities will create huge problems for an already deficit budget, and the key is to remove from the vertical the “glue” by which it is held. Combined with the lack of prospects of victory in the war, this is quite enough for the vertical to start collapsing. Theoretically one could try to replace the oil rent with another, but the transition process is very risky for the regime because of the internal tensions within the elite it generates.

Moreover, these tensions are already beyond all measure. Putin started out as the supreme godfather of the mafia formed before him; accordingly, the entire “elite” is mostly hedonists who came to power to “make money.” But at least after the defeat of the “White Ribbon Revolution,” which, against the backdrop of the “Arab Spring,” badly scared the boss-in-chief, he began slowly, so as not to “pop the frog,” to turn the wheel toward fascism. And fascisation requires quite different qualities, including from the supreme leader, among others, and must therefore be accompanied by a change of elites, which has gradually happened, starting from the regional level. This process would have gone smoothly, from the bottom up, if the ‘SVO’ (Specialised Military Operation) had been successful in Ukraine. But no, the war forced a sharp acceleration of the replacement of elites, in the fascist spirit, with “soldiers and workers”.

Capping Russian oil profits

It seems time to strike a decisive blow, especially since an asymmetric nuclear response to it is hardly possible (at least the military would not understand such an order), but, alas: the West’s reaction to Prigozhin’s putsch a year ago made it very clear that, in the United States at least, the mainstream fears possible chaos in a nuclear power more than its growing fascism.

Potentially disruptive to the regime, the proposal to influence the Kremlin through a “sealed” price cap with a subsequent scheduled reduction to $20-30 per barrel was rightly called “the most important sanctions measure” in a report by the Kiev School of Economics of the Ermak-McFaul group. In the very next report, however, this proposal was replaced by the much less dangerous for the regime reduction to USD 50 per barrel, with an emphasis on the balance of payments implications.

And the “sealing” itself is performing poorly. Recall that the main mechanisms for limiting the price of Russian oil exported by sea are prohibiting companies registered in countries that have joined the sanctions from transporting more expensive Russian oil or insuring such transport. In response, the Russian Federation purchased a hundred old tankers and began sailing them under false insurance policies issued by fictitious insurers, with reinsurance (mandatory but actually fictitious) with Russian insurance companies.

The West turned a blind eye to these outrages for a long time. Late last year, however, the US began imposing sanctions on tankers carrying Russian oil at prices above the cap, and this has had an effect. The same group’s report proposes a number of other measures that are perfectly capable of making the cap effective. Among them is a ban on tankers without proper insurance to pass through the territorial waters of the countries of the sanctions coalition, including Denmark, that is, actually leaving the Baltic Sea, and this, for a minute, is 60% of Russia’s oil exports. \\\ this sentence was missed all together. It is worthy to check the text for such mistakes \\\ It is also proposed to introduce penalties against companies that reinsure risks for such transport. But for almost six months there was no political will for all this, so even the discount on Russian URALS oil compared to BRENT has almost disappeared.

The ice suddenly broke in mid-June: the United States finally imposed sanctions against Russian shipping companies and reinsurers (but not all), and then, as part of the 14th package, the European Union began imposing sanctions against tankers. Then Denmark remembered the idea of the straits. At the same time, the restrictions are naturally aimed not at oil exports as such – that could lead to higher oil prices, which is highly undesirable for Biden ahead of the election – but at sealing the pricecap, which reduces the rents from oil exports while forcing Russia to increase supplies. 

The impetus for this seems to have been the extremely arrogant ‘peace proposals’ made by Putin on the eve of the Peace Summit. There is hope that someone in the West has become convinced of his unwillingness to negotiate in good faith, but more likely this may be a retaliatory move – a signal to Putin that he needs to be more forthcoming and come up with more realistic initiatives. However, he can hardly soften his approach unless the alternative is guaranteed regime collapse.

But here, most likely, the effect of the “warm bath” in which he is kept by his subordinates is at work, so this option, fortunately for us, is unlikely. The same effect acts as an additional insurance against possible nuclear escalation.

In any case, the West seems to know where Achilles’ heel is – the point is to convince the leaders: there is simply no good outcome with a victory while preserving Putin’s regime (i.e. without the risks of a collapse of the Russian Federation), and toppling that regime through a partial and somewhat controlled collapse of the power vertical is the least evil of all realistic options. And defeat, including any compromise with the aggressor, even if it were possible, would be very costly: it is a new arms race (military spending is increasing several times, from 2.4% in 2021 to 6.3%, which characterizes the height of the Cold War and the rise of violent dictatorships around the world (Hamas, the Hussis and Maduro’s claim to Guyana are just the beginning) and the collapse of globalization.

Meanwhile, the Putin regime has already set foot on the slippery slope of fascisation and is unlikely to stop. This means that the result of its evolution will be something between the DPRK and Nazi Germany, and not at all a stale late Soviet times.

At the same time, if the change of elites and the policy of “self-reliance” (known as Juche, the DPRK’s official ideology) succeed, then the regime will indeed become as invulnerable to sanctions as its North Korean role model.

It is very difficult for Western leaders to admit this, but the process of cognition, judging by indirect signs, is moving in the right direction. The task of Ukraine and all its conscious citizens who have access to a Western audience is to work on opening of the Overton window..

A similar version of this article was originally published on ZN.ua

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