The New Russian Sanctions Playbook

After Russian President Vladimir Putin launched a full-scale invasion of Ukraine last week, U.S. President Joe Biden made good on his threat to impose “swift and severe consequences” on Russia’s economy. His administration has enacted a set of sanctions far stronger than those deployed in 2014, after Moscow’s last incursion into Ukraine. This latest package includes sanctions on Russian banks, debt and equity restrictions on state-owned enterprises, and unprecedented multilateral export controls designed to cut Russia’s high-tech imports in half.

These sanctions, coupled with similar measures from the European Union and other U.S. allies, will accelerate Russia’s isolation from the global economy. Such moves, however, are not a sign of policy success—despite the impressive transatlantic diplomacy. On the contrary, they represent a failure to deter Putin from invading Ukraine. It is possible that the threat of sanctions failed because Putin was determined to invade regardless of the cost. It is also possible that Putin underestimated the damage that Western sanctions would cause. The 2014 measures sent Russia’s economy into a tailspin, but the country stabilized after several years.

Just because threatening sanctions failed, however, doesn’t mean the United States should abandon them altogether. Beyond exacting a price for military aggression and signaling solidarity with Ukrainians under fire, punitive economic measures can demonstrate to Russian elites and society that Putin’s imperial fantasies have costs. Declining living standards and diminishing prospects could, in turn, weaken Putin’s domestic base of support, siphoning attention and resources away from foreign policy.

Over the long term, economic penalties can also degrade Moscow’s ability to project power abroad. With Russia’s army already deployed across Ukraine—and little prospect for a dramatic shift in Russian foreign policy while Putin is in office—sanctions are now less a tool of behavioral change than one aimed at economic and technological attrition. Their primary objective is no longer to deter Moscow from taking particular actions but to drastically alter the trade and investment links between Russia and the United States and its allies—to the latter’s geopolitical advantage.

THE FIRST WAVE

The United States and its allies had sanctions ready to go within hours of Putin’s decision to move troops into Ukraine. In the weeks before these measures were announced, the Biden administration hinted that it would target Russia’s state-owned banks and impose a bevy of technology-related export controls. It has actually gone further than that, imposing debt and equity restrictions on large state-owned enterprises in virtually every important sector of the Russian economy, including gas, diamonds, and rail transport.

The most impactful sanctions, however, have been the penalties Washington levied on Russian financial institutions. On Tuesday, after Putin recognized two breakaway regions in eastern Ukraine, the Biden administration implemented “full blocking” sanctions—a complete asset freeze and transaction ban—on VEB.RF, a bank that operates as a Kremlin slush fund with over $50 billion in assets. This marked the first time the United States had used its most fearsome sanctions cudgel against a major Russian state-owned bank.

On Thursday, after Putin ordered a full-scale invasion, Washington used that cudgel again against VTB, Russia’s second-largest bank. It also imposed a transaction ban—a less draconian but still significant limitation—on Sberbank, which is by far Russia’s largest financial institution. Through it all, the EU has remained in lockstep with the United States, levying a similar array of restrictions on Russia and agreeing not to certify the Nord Stream 2 pipeline carrying natural gas from Russia to Germany.

U.S. and EU sanctions will undoubtedly intensify in the days and weeks ahead. Over the weekend, for instance, Canada, the United Kingdom, the United States, and the EU announced their intention to enact new measures targeting Russia’s central bank and kicking certain Russian banks off SWIFT, the interbank messaging system. Although the United States and its allies have not yet unveiled the details, these actions, in their most ambitious form, would amount to a virtual financial embargo of Russia. Putin has amassed more than $600 billion in foreign currency reserves, but a significant share of that pile could become unusable if the United States and Europe imposed severe limitations on the country’s central bank. Such measures were unthinkable a week ago. That they are coming soon indicates just how rapidly attitudes are shifting in the United States and Europe as Putin’s war gets uglier.

Sanctions are now aimed at economic and technological attrition.

Still, the recently imposed U.S. and EU sanctions on Russia are not as comprehensive as those in place against Iran. At present, only one of Russia’s five largest banks is subject to full blocking sanctions. By contrast, all major Iranian banks, including the Central Bank of Iran, are fully blacklisted. All major Iranian state-owned enterprises, including the National Iranian Oil Company, are also under full blocking sanctions. Critically, the United States has also used the threat of so-called secondary sanctions—measures targeting third parties that transact with sanctioned entities—to drastically reduce Iran’s oil exports and isolate Tehran almost entirely from the global economy. No such sanctions are currently in place against Russia.

Thus far, U.S. and EU measures against Russia have focused on the country’s financial sector while largely sparing its energy industry. Tough sanctions on oil and gas sales, by far Russia’s most valuable exports, will be politically difficult because markets are tight and the Biden administration worries about the impact on domestic gasoline prices and inflation. The EU, meanwhile, needs Russian gas to make it through the winter. Washington and its allies are therefore likely to max out sanctions on Moscow’s banking sector before considering measures that target the energy sector directly.

Nevertheless, the Ukrainian government and much of the international media have fixated on cutting Russia off from SWIFT. In truth, however, it would make little sense to cut Russia off from SWIFT unless the United States and others had already sanctioned the country’s major financial institutions. Severing SWIFT access first, without imposing maximal banking sanctions, would perversely increase demand for SWIFT alternatives, including Russia’s own interbank communications network. Because SWIFT is a communications mechanism, rather than a tool for transferring actual funds, international banks would also still be permitted to engage with their Russian counterparts; they simply couldn’t use SWIFT to facilitate their transactions. Sweeping sanctions on the Russian banking sector should therefore precede a SWIFT ban. This approach appears to be the preferred U.S. and European course of action, as states begin imposing SWIFT bans on specific sanctioned banks instead of a blanket prohibition on Russia.

A NEW SANCTIONS CALCULUS

As U.S. and EU sanctions intensify, Russia’s economy will undoubtedly suffer. The country’s stock market and the ruble will plumb new lows, inflation will jump, and financial distress will set in. Living standards will fall, and economic disruption might pressure Putin to end the war. In such a hopeful scenario, Washington and others should be prepared to relieve some of the most draconian sanctions. But this is not an outcome the United States and its allies can count on. What Washington and others can count on, however, is that sanctions will worsen Russia’s position in its long-run competition with Western countries—reducing Moscow’s overall ability to fund its military and project power. Sanctions can facilitate this process in several ways.

For one, financial penalties will slow Russia’s economic growth. The country’s economy will probably shrink this year due to Washington’s and Brussels’s existing sanctions. By throwing a wrench into the Russian financial system and further cutting Moscow off from international capital markets, the sanctions will reduce overall investment, dragging down the country’s long-run growth rate. Sanctions will also impose some costs on Western countries, too, which policymakers can’t ignore—including higher prices for Russian commodity exports such as oil, gas, and many types of metals. Nevertheless, the U.S. and European economies combined are more than 20 times as large as Russia’s economy. Even if sanctions imposed equivalent costs on them and on Russia—and usually, they hit Moscow far harder—Russia still would end up substantially worse off in relative terms.

Another way that sanctions can limit Russia’s ability to project power is by complicating Putin’s domestic calculus. Escalating economic discontent at home could spur the Kremlin to shift resources away from its military and foreign policy priorities and toward supporting living standards. Even if no such shift occurs, Putin’s domestic position will inevitably become more tenuous. Over the past decade, the Kremlin has presided over declining living standards, in large part because sanctions-induced stagnation has made it impossible for Moscow to support both domestic prosperity and an expansive foreign policy. Putin’s popularity has declined meaningfully as a result. The more attention the Kremlin devotes to controlling domestic politics, the fewer resources it has for further aggression abroad.

Sanctions can limit Russia’s ability to project power by complicating Putin’s domestic calculus.

Finally, sanctions and export controls can limit Russia’s ability to produce and develop advanced military equipment. Moscow is immensely reliant on foreign technology—including machine tools, software, and semiconductors—and Russia already struggles to produce large quantities of certain military equipment such as precision munitions. U.S. limits on technology transfers to Russia following the Kremlin’s 2014 invasion of Ukraine, for instance, caused painful delays across Russia’s military-industrial complex, including the manufacture of its global positioning GLONASS satellites.

Now, the United States and its allies are again tightening controls over an even broader array of items. These technologies are relevant not only to military systems but also to civilian industries, such as aviation. Western countries should continue to broaden these controls to limit Russia’s ability to acquire advanced manufacturing, robotics, and automation skills. The lower the overall capacity of Russia’s manufacturing and technology sectors, the less able the Russian defense industry will be to acquire the expertise it needs to build advanced military equipment. To prevent Russia from developing additional manufacturing, computing, or software-programming capabilities, Washington and its allies should more fully sever these sectors from access to Western technology.

THE ESCALATION DEBATE

Given that Washington and allied states are still escalating sanctions pressure against Russia, the Biden administration will need a strategic framework for what it hopes to accomplish with future measures. Washington is past the point of hoping that sanctions can push Russia toward any specific policy. Instead, the question needs to be whether continuing a given type of trade or investment relationship will improve the United States’ position vis-à-vis Russia over the next decade. In many cases, the answer will be no.

This type of reasoning can be uncomfortable for many U.S. and European officials, who understandably prefer economic policies that leave everyone better off. The alternative vision, by contrast, is based on a zero-sum logic of power politics and implies ongoing costs for Western economies. Like it or not, however,  the United States and Europe’s relationship with Russia is now mostly zero-sum. There is no doubt that Moscow sees the relationship in such terms. The sooner the United States and its allies come around to this view, the stronger their position vis-à-vis Russia will become. Any measures that are somewhat costly to Western countries but very costly to Russia leave the former better off.

Such a shift in strategy will not be politically easy for Western democracies to make. Russia’s rulers benefit from a vast apparatus of repression that lets them suppress discontent. Western leaders, by contrast, must answer to voters who care deeply about their wallets. Such political calculations have already influenced policymaking. Sanctions designed to choke off Russian oil exports, for instance, would increase energy prices, at least in the short term. Fearing domestic backlash, many U.S. and European leaders are therefore opposed to such measures.

Political leaders must be open about the fact that sanctions involve tradeoffs.

Nevertheless, the horrifying images of Russian artillery striking Ukrainian cities provide an opportunity for Western leaders to clarify the stakes of the current crisis. Russia’s oil and gas export earnings feed Moscow’s military machine. If the United States and others managed to curtail the Kremlin’s ability to earn hard currency—which can be done most effectively by limiting oil exports—Russia’s position would be far weaker.

Political leaders, however, must be open about the fact that such a policy involves tradeoffs. Tightening export controls on Russia will reduce Western firms’ sales there—although, with only three percent of the world’s GDP, Russia is a small market for most companies. Cutting off Russia’s commodity exports, which would challenge the Kremlin’s ability to fund its foreign policy, would also raise prices for Western consumers in more serious ways—impacting everything from metals to gasoline.

Ultimately, however, the role of sanctions and export controls now is to change the structure of Washington and its allies’ economic relationship with Russia, ensuring that whatever trade remains benefits the United States and Europe more than it benefits the Kremlin. These measures will not be costless. But letting Putin harvest the benefits of the global economy to feed his military hasn’t been costless either.