Thursday, November 27, 2014

Sanctions and Solidarity

BRUSSELS – The European Union has finally agreed on its “third-level sanctions” against Russia for its actions in Ukraine. As is usual for the EU, arriving at this point has been a long and difficult process.

A key problem all along has been that, though sanctions serve a common purpose, the costs of implementing them are borne by individual member states. Moreover, the costs are very concrete and visible, as jobs in enterprises that depend on exports to Russia seem to be at stake. So it was not surprising that many member states were more concerned about the potential cost of the sanctions on their economies than they were about the overall foreign-policy goal of signaling to Russia that its disregard of international law and norms has consequences.

That is why a common fund to provide compensation for the economic costs of sanctions should be an integral part of the EU’s emerging foreign-policy stance toward Russia. Creating such a fund would provide a potent symbol of solidarity within the EU, while providing an ideal opportunity to reflect on the nature of the sanctions’ costs.

From an economist’s perspective, a key point is that losing export sales does not represent a cost per se. For example, if a company that produces a generic consumer good like food, or even cars, sells less in Russia than it did before, one should not necessarily count the reduction as a loss. After all, if such goods have a global market, a loss of sales in one market can be compensated by higher sales in another.

In fact, a large proportion of Russian imports from the EU are precisely of these generic consumer goods, which are not affected by sanctions. Thus, reports claiming that sanctions imply a high cost – because EU exports to Russia amounted to €120 billion ($161 billion) last year and represent tens of thousands of jobs – are highly misleading.

An economic loss arises only if a firm produces some specialized good that can be sold only in Russia using labor and capital that are also specialized and cannot be employed to produce something else. This applies especially to Germany: The famous German Mittelstand often does produce highly specialized goods; but it also prides itself on its flexibility and adaptability. Given this, there might be a case for compensation in some cases, but it should be strictly limited in time.

It would not be difficult to develop objective criteria for access to an EU “Sanctions Compensation Fund.” A firm could be eligible for compensation if it operated in the sectors covered by sanctions, and if the product in question had special characteristics that prevented sales from being redirected elsewhere.

A quantitative test of eligibility could be that sales to Russia over the previous three years accounted for more than one-quarter of total sales and diminished by more than a certain percentage this year. Compensation would take the form of retraining programs for personnel, and maybe refinancing of loans taken to finance specialized machinery.

But there are two sectors in which no compensation is needed: energy and finance. Why?

For starters, the risk to Europe’s energy imports from Russia is negligible. Should Russia demand a higher price for its oil, Europe could simply turn to the global market. Likewise, Russian gas giant Gazprom could increase the price it charges its European customers only by breaking existing contracts. Moreover, Europe is the only customer for a large share of Russian gas exports, which, at least in the short run, must be transported through the existing pipelines.

Given this, the case for compensation in the energy sector is exceptionally weak. Only the makers of highly specialized equipment, perhaps for exploration under Siberian conditions, might have grounds for drawing on the compensation fund.

The case for compensation is even weaker in the European financial sector. Providing the kind of medium- to long-term financing that is now subject to sanctions constitutes an infinitesimal fraction of European banks’ business. Moreover, as Russia’s political system becomes ever more oppressive, and its legal system ever more arbitrary, rich Russians will be more inclined than they already are to establish a safe base abroad for their wealth and families. The freedom and rule of law provided by financial centers such as London will become even more attractive.

In 2006, the EU established a “Globalization Adjustment Fund” to cushion those sectors hardest hit by rising imports. Though the Fund initially was allocated only €500 million, a rather modest sum compared to the overall annual EU budget of around €100 billion, its creation was an important signal of the EU’s readiness to compensate those who lose out from a common policy.

A similar political signal is needed today to overcome EU member states’ resistance to decisions that advance a common foreign policy. Here, too, the sum needed would probably be rather small compared to the overall EU budget.

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    1. CommentedDavid Morgan

      I am happy to see France stop the delivery of it#s Mistral type ship to Russia. There are other customers out there, and as mentioned in this article compensation. This brings another point to life, Russia is very bad at making hi Tech equipment, a majority of the electronics for their rocket engines sold to the US originates in the US. In the future when the UN Security Council has a long overdue overhaul, the permanent members needs to be radically changed. This may not go down well with the current occupants, however change is desperately needed. Both Britain and France needs to go and the EU be given permanent member status. Russia needs to go for flagrant breach of international law. India is a possible replacement ad we all know that Japan is desperate for a seat. All Japan has to do is admit past atrocities perpetrated in WW2, IE Nanking massacre, comfort women and the abysmal and sadistic treatment of allied prisoners of war. Pay compensation and reparations, and within a thousand years it should get a seat. OUtSIDE.

    2. CommentedPhilip Larmett

      Some very valid points are made.
      I'm not sure whether the damage to trade (and European manufacturing jobs) is greater from the EU sanctions on Russia or from Russia's own retaliatory measures against European foodstuffs and other goods.

      Certainly, banning European food products will have an effect in urban Russia (especially Moscow and St Petersburg). Polish apples, French Camembert, Italian Mozzarella will all disappear rapidly from the shelves of such elite supermarkets such as Azbuka Vkusa. The urban elite will go without. The Russian rural population never knew what they were missing anyway.
      Russia has already found a willing substitute. Yesterday in Sochi a trade deal with Egypt was done; new potatoes and other produce will be supplied in the Russian winter. Dutch glasshouses will lose their trade.
      But Dutch flowers from the same glasshouses? Have they been banned?
      French wine? I heard it had not been banned?
      Mercedes, BMW, Porsche and Audi? Has Russia restricted imports? I'm not sure that the German manufacturers could find alternative for such lucrative trade; I'm not sure we could call them in any way generic. And I'm not sure the Russian elite would accept such a restriction of choice.

      And what about Ukraine? Will it announce restrictions on tourist travel to Egypt in retaliation for its trade deal with the enemy? Where will the Ukrainian middle-class go for winter holidays if Egypt openly sides with Russia?

      Time will tell if any of this works...

    3. CommentedPhilip Larmett

      There are two issues here.
      What exports has the EU specifically banned?
      And what imports has Russia specifically banned in retaliation?

      Polish apples, French Camembert and Dutch/Spanish vegetables and fruit in the winter are going to affect the lifestyles of the new Russian middle class in the big cities who can go to supermarkets like Azbuka Vkusa. The Russian rural population never knew what they were missing anyway.

      But I notice that French wine has not been banned...
      Nor has baby food...
      And Russia has done a deal with Egypt (yesterday) to source potatoes and other produce scarce in the winter. Import substitution...

      Have Mercedes, Porsche. Audi or BMW vehicles been banned by either side? These are, according to the article, generic consumer goods, which can be sold elsewhere... I'm not sure either the German manufacturers of elite automobiles would like to lose this lucrative business, nor that the Russian elite can find many alternatives... Range Rover? British-made under the control of an Indian multinational. Could be shipped through India to avoid sanctions... Lexus and Infinity: the Japanese elite brands are also well represented in Russia.
      Will the Ukrainian government react by banning Ukrainian tourism to Egypt in retaliation for its trade deal with the enemy?
      We'll see.

    4. CommentedNathan Weatherdon

      It's not really very clear to me what exactly is at stake. Are EU exports to Russia really that prolific? What are these "generic consumer goods"? Does Russia really think that the outcome will be anything other than a repeat where they become known for producing substandard goods? I mean, who ever really wanted to own a Lada if they had access to any other possible alternative?