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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.