The Sword and the Shield: The economics of targeted sanctions

Date July 21, 2022
Speaker Daniel AHN (Global Fellow, Wilson Center)
Commentator TAKEUCHI Maiko (Consulting Fellow, RIETI)
Moderator SABURI Masataka (Director, PR Strategy, RIETI / Special Advisor to the Minister, METI)

The Russia-Ukraine War of 2022 has unleashed the most comprehensive sanctions regime against Russia in recent memory. However, questions remain as to how effective they would be? Dr. Ahn shall discuss his research into the effects of the previous US-EU sanctions regime from 2014 to 2016, the first study using detailed firm and individual-level data to precisely measure the empirical impact of targeted sanctions. Dr. Ahn shall describe his findings, his hypothesis into the mechanisms on how sanctions work, how the target responded, their policy implications, and some lessons for today and for future sanctions regimes.


My research focuses on understanding the economics of how sanctions have been working as a tool of economic statecraft and national security, with an eye toward sanctions on Russia between 2014 and 2016, and more recently today.

Sanctions harm economies, firms and individuals by causing revenue loss, asset value depreciation and unemployment. Targeted sanctions are typically effective in causing damage to the targets despite some sanctions being remedied by target countries via bail-outs or shielding. However, there is also de-risking occurring in the private sector that complicates targeted sanctions effectiveness. Nevertheless, controlling regimes and ultimately taxpayers take the burden of the costs of such shielding, making targeted sanctions broad reaching, and necessitating the use of soft power to emphasize the regime’s role. Reliance on components or services enhances the effect of sanctions and shows that competitiveness is critical to maintain sanctions effectiveness.

Effect of sanctions in use against Russia from 2014 to 2016

The U.S. and EU sanctions against Russia from 2014 to 2016 and data collected by the US Department of State brought to light how generally the economics of targeted sanctions work. By assessing all the way down to the micro level of company and individual level economic data, precise measurement can be obtained of the impact of sanctions on a company or individual. Generally speaking, these sanctions cause a company's revenue to fall by a quarter, asset valuation to fall by one half, and the number of employees to fall by one third. In particular, sanctions seem function due to the denial of Western service inputs into Russian production.

The impact is much greater for companies and business sectors that are dependent upon Western service inputs. However, there is a subcategory of sanctioned targets that are shielded by the state through subsidies, bailouts and other mechanisms that makes sanctions appear misleadingly ineffective for some targets. This shielding by the Russian state actually causes us to underestimate what the true impact of sanctions are. The data show that sanctions reduced Russian GDP by about 4.2% of GDP during 2014 to 2016 however with this shielding by the government taken into account, the figures reach as high as 7.5% of GDP.

Dramatic growth of targeted sanctions

Sanctions have been a very long-standing tool of economic statecraft, used against states such as North Korea, Cuba, Iran, Iraq, etc. Most recently there is a new class of sanctions called targeted sanctions, or smart sanctions, that instead of sanctioning an entire country, sanction specific individuals, entities or transactions. Targeted sanctions have dramatically grown in popularity since 2000. Because the type of sanctions have shifted from the macro to the micro-level, the tools used to study them should also shift from the macro approach to embrace more micro-relevant analysis.

Some types of sanctions block or prohibit any transaction between Western entities and the sanctions’ targets. This also includes majority owned subsidiaries. Other sanctions are sought against individuals, banning companies from conducting transactions with said individual. Finally, there are sectoral sanctions which prohibit some types of transactions like technology transfer or maritime insurance provision.

Micro approach to data

To analyze their effect, we must measure macroeconomic data, because the sanctions themselves were macroeconomic in nature, however, it is also important to analyze microeconomic data too. Macro effects such as oil shocks have a broad impact that could be entangled with the effect of sanctions, leading to misunderstandings. In order to measure and account for these effects we linked databases such as Bureau van Dike’s Orbis Database for companies and the LexisNexis WorldCompliance database of relationships between individuals and firms. Thus, the number of companies that were sanctioned by the US and the EU from 2014 to 2016 and the number of individuals that have been sanctioned by either the US or the EU is then revealed. The data can be divided into political targets and individuals that have business connections.

The shield

Most targets of sanctions do seem to see a large decrease in their economic performance, however, there is a subcategory of companies that do not seem to be affected at all. These companies were being shielded by the Russian state either by tax breaks or very large government contracts or loan guarantees. This effect needs to be controlled for. One example is VTB Bank which after it got sanctioned received billions of dollars in state aid. In addition, Bank Rossiya received a very rich electricity contract from the Russian government after it was sanctioned. Defense contractors have also received large state orders after they got sanctioned. We need a method of determining which companies may receive such protections.

After analysis, we find very powerful, statistically significant effects of sanctions after a firm gets sanctioned. On average, the firm has a 3% higher probability of bankruptcy. Operating revenue falls by one quarter and total asset valuation falls by one half. The number of employees falls by one third. We use a sector control group to control for any kind of macroeconomic effect like oil prices, ruble exchange rates or any other sort of macroeconomic factor.

So naively extrapolating the cost of all of these sanctions, via national accounting, we see a 4.2% drop from Russia's pre sanctions 2013 GDP. There is a very big negative impact from 2014 but it is reduced in 2015. And then by 2016 the effect is completely gone. The strategic firms saw no actual impact from sanctions.

So, why are these companies seeing no economic impact? It is because the Russian state is bailing these companies out by transferring economic resources to them. However, the hurt of the sanction is moving from the sanctioned firm to the Russian government. We need to include the cost of the bailout to the Russian government as well in measuring how impactful these sanctions are. With this taken into account, it actually increases the overall lower estimate to 7.5%, so ignoring the shielding effect of government protection underestimates the effect by almost half.

Sanctions can hurt firms by stopping exports to the West (which is not a major factor in the case of Russia as it is mainly a fossil fuel exporter), and by denying Western service inputs into the Russian companies. This means that companies that are more dependent upon Western inputs should be more vulnerable to sanctions; however, companies that are more dependent on gross Western inputs do not show a significant impact from sanctions. But companies dependent on Western service inputs for which there is no substitute show a significant economic impact.

Policy implications

There are many policy implications to be gleaned from these findings. Smart sanctions seem to concentrate economic harm on the targets themselves. However, they could still be smarter as there is evidence of spillover onto non-sanctioned firms. We should also remember that by disconnecting the economic relationship between the West and Russia, it also hurts Western companies. Western companies also face the burden of implementing all of these sanctions. This is a major cost and something that policymakers should think about. Other knock-on effects include de-risking from certain regions entirely to avoid costly compliance.

Another policy implication is that firms may be reluctant to deal with hazardous sectors. This can weaken the incentive of targeted firms to change their behavior because if the sector is largely abandoned due to compliance costs, there is no benefit to returning to the now-abandoned sector. Furthermore, these sanctions work by denying key Western technologies and services, which the West essentially has a quasi-monopolistic position on, like in sectors such as financial services or microchips. However, these sanctions reduce Western competitiveness in these sectors through the burden of compliance and the incentivization for other firms in the sanctioned country to develop alternatives and substitutes to replace those lost services.

The sanctions policy process could also use more economists, statisticians and data scientists to help design the sanctions to make them most impactful upon the target, while least damaging to Western economies.

Relative dependency matters

Relative dependency matters. When you are trying to decide who has more powerful sanction tools, you have to think who is more dependent upon the other and who has more substitutes than the other to ensure that counter-sanctions are not a threat to Western companies.

While there is no real alternative for a high tech Nvidia graphics chip from the US or some great robotic high precision instrument from Japan, there are many alternatives to Russia’s main fungible export of hydrocarbons. So that is why Western sanctions work against Russia. But Russian counter-sanctions against the West do not really work.

Regarding shielding, a company should not be sanctioned necessarily with the expectation that that target is going to get damaged. The data suggests that the target will get damaged, but if it is an important target to the Russian regime, then the Russian regime will protect it. A bailout could equalize any impact. However, this may a good thing as ultimately the Russian regime pays the price.

An authoritarian regime that has full power over how resources get allocated within the state will be able to “unsmart” sanctions by moving resources around to protect its elite and instead impact the broader populace. It is, in fact, the Russian state that is taking resources away from the Russian people and bailing out its elite. Therefore, these smart sanctions should be combined with good soft power, messaging and communication to make this clear to the populace of the sanctioned country.

Recent sanctions due to the Ukraine conflict

Unfortunately, because it is so recent, this data is not as clear as the data from the previous study from 2014 to 2016. But it is clear that in this most recent round of sanctions, the number of specific entities that have been targeted by the U.S. has more than doubled, but the line between smart and country sanctions is increasingly blurry. Nevertheless, it is true today that while it is the government that chooses the sanctions policy, it is the private sector that actually implements the sanctions. And there has been reporting of self-sanctioning by private companies because of reputational risk or because of compliance costs. This is magnifying the impact of sanctions beyond officially what the Western governments have chosen to do, and this may not necessarily be a good thing. Also it is essentially impossible to sanction oil, so there is no point in pursuing such measures, although tariffs may be reasonable.

It is very important to try and maintain the monopolistic position of key technology and financial services by the West. One great success has been the freezing of Russian central bank and other official assets in the West. It was a very big mistake by the Russian government not to inform the Russian central bank of the plan.

But we should also recognize that there is a limit to how far sanctions can go. The ultimate limit of smart sanctions would eventually equal a countrywide embargo. However, sanctions against Russia cannot bring down the Russian economy as it is too large and resource rich.

Comment and questions

This research is truly useful for practitioners to consider whom to designate. This research on Russian targets will not be applied directly to sanction regimes against other countries. For example, in the case of North Korea, similar information is not always available.

Nevertheless, I believe this research is useful for policymakers to think about how to strategically designate target entities. Furthermore, this research attempted to answer whether sanctions work, and how to consider the unintended negative impacts of sanctions on citizens.

In summary, Dr. Ahn showed that sanctions harm the economy, the entities, and the individuals of the targeted country. The impact is assessed by both direct impact and also the cost for the government to bail out or shield the sanctioned entities. If the government bails out particular strategic entities, then the cost is eventually paid by the targeted countries’ taxpayers. In that sense, smart sanctions are not so “smart” but rather the impact is closer to that of comprehensive sanctions as it affects all of the citizens. However, it does not necessarily mean that such sanctions are “bad.” It is the regime's choice of whether to save the companies and continue the actions which caused the sanctions, at the cost of the wealth of the citizens.

The sanctioned entity's reliance on third countries, especially the West, including Japan or other technologically advanced countries’ components or services strengthens the effect of economic sanctions. So, technological superiority is important. This is directly relevant to one of the Japanese government’s hot issues, economic statecraft. METI is the leading force in pursuing strategic export controls, which controls the transfer of specific advanced technological items. This empirical analysis is also a great resource to help policymakers to choose technologies and industries to be the subject of strategic export control.

Let me ask questions. Economic sanctions are part of economic statecraft, and countries always take into consideration domestic economic impacts before imposing them. As you mentioned, the cost of the government shielding strategic companies is eventually paid by the citizens of the targeted country. Reliance on Western services or components strengthens the impact of the sanctions, but then that means Western companies also lose access to the Russian market. If so, do you think the cost is also partially borne by the sanctioning country? You already pointed out the cost of sanctions for the sanctioning countries such as for sanctions compliance and de-risking, but in addition to these, do you see the cost of sanctions caused by the loss of the Russian market?

How can you further develop your research to assess the true impact of sanctions on the US or Western industry? With the current war in Ukraine, we have seen Russia take counter-actions against sanctions imposed on it. Particularly relevant to Japan, for example, Russia has taken over the Sakhalin II gas and oil project and implemented payment impediments to Western businesses using “type C accounts”. I understand we do not have data yet to apply the same methodology you have done. But can you discuss a bit more about how the impact of the counter actions are expected to play out?

As the title is “the sword and shield”, let’s turn the tables. If you had been the Chief Economist of the Russian Foreign Ministry from 2014 to 2016, how would you have proposed to mitigate the impact of the sanctions? What kind of counter-measure would you have proposed? In other words, how could Russia have countered the previous and current Western sanctions?

Daniel AHN:
The first is a very important question because we need to recognize that we always talk about sanctions like a weapon. But it is, in fact, the disconnection of our relationship. And in this case is the West that is choosing to disconnect an economic relationship.

But a relationship, as always, goes both ways. So, when an economic relationship or a trading relationship just gets disconnected both sides feel an impact. But in the case of the Western aligned countries including Japan, South Korea and Australia and so on, I think the impact has been relatively milder, because Russia is very dependent upon a lot of Western inputs that there are no substitutes for.
But there is still some impact from the denial of the Russian market to Western companies. In the case of the US, I think it was like 1% of US total exports goes to Russia, so, it is relatively small. In the case of the EU, the countries that seem to have more dependency on Russia as an export market are also the same countries that were more eager to impose the sanctions against Russia; countries like Poland, Finland, Estonia, Lithuania, and Latvia. I think probably the most important measure of how impactful sanctions can be is the degree to which your exports are substitutable.

In the long run, it is all about if you can make sure that your imports have many sources so that they are more substitutable, and you are not dependent upon one country. And conversely, you need to make sure that your industries are in such a strong competitive position that you are the only suppliers of a certain key goods. That is the way to maximize your impact of sanctions while mitigating the impact of countersanctions.


Can you think of any reason that some sanction-affected goods may be more easily substituted?

Daniel AHN: It is the elasticity of substitution which means to measure how difficult it is to find a substitute for a particular good or service. Oil is an example of a commodity that has almost a perfect substitutability. If you are a refiner, you do not care whether your oil is Russian or Texan. But it may be very important to have a special microchip that comes from Japan and not some cheaper microchip that comes from China, for example.

Do you have any methods to measure relative dependency, for example, between the US and China? The interdependence is very important. So, which is better of the soft sanctions and the hard sanctions?

Daniel AHN:
Regarding measuring relative dependency, you should not focus on gross dependency and gross market share, but measure the elasticity of substitution for these industries. But it is hard to do. Actually, one of my recommendations when I was in the US government was to create a sanctions office that exactly does this research.

What kind of sanction do you think would be most effective to push the Putin administration to change their policies related to the invasion of Ukraine?

Daniel AHN:
My impression has been that the targeted sanctions have only enhanced Putin's power within Russia because Putin's government can now choose who gets bailed out, who gets shielded and who does not get shielded. In fact, I think it has enhanced Putin's control over the oligarchs, because he can choose whether or not to bail them out. The oligarchs have no other choice effectively.

We do not focus enough attention on defenses against counter-sanctions. And maybe Russian counter-sanctions have not been very effective because they do not produce anything that has low elasticity substitution. But if we were to sanction China it would be difficult, as it has industries with no good substitutes.

Final remarks

I would echo your comments, that the West, we, need more strategically planned sanctions and countermeasures. And so, I totally agree with you, Dr. Ahn. I saw a lot of deliberation in the Japanese government and in the United Nations. But, we have Dr. Ahn’s research showing one clear way of how we can prioritize or what we can do through scientific criteria.

Daniel AHN:
This is only chapter one of a new sort of understanding of how sanctions can work. I look forward to more close discussions. Initiatives like this that METI does are a perfect example of the greater cooperation and cross-fertilization of ideas between these two communities of experts to better improve our economics and our national security.

SABURI Masataka:
Thank you, Dr. Ahn. And thank you, Ms. Takeuchi. This was a very impressive presentation and I enjoyed this very much. As Dr. AHN mentioned, we have to study more about the sanctions. We have a long history of military studies but economic and social studies are still young. So, we have a lot of catching up to do. Thank you very much.

*This summary was compiled by RIETI Editorial staff.