How sanctions against Russia could backfire

Since President Vladimir Putin's ill-fated invasion of Ukraine, Russia has been expelled from the Western financial system and punished with a variety of international economic and financial penalties. Addressing the World Economic Forum earlier this week, Ukrainian President Volodymyr Zelenskiy called for "maximum" sanctions so that Russia "clearly knows the immediate consequences of their actions".

Policymakers often view such measures as a relatively quick and painless way for law-abiding nations to punish transgressors. But history shows their efficacy is doubtful and, at times, they can seriously backfire. Besides, if there's one country that has proven it can withstand sanctions, it's Russia.

According to Nicholas Mulder's timely new book, "The Economic Weapon", sanctions were first deployed by Athens, which imposed a commercial ban against the Greek port city of Megara in 432 BC. But their use only took off during World War One, when Britain and France constructed an extensive economic blockade against Germany and its allies. After the war, sanctions were seen as a tool to keep nations at peace. US President Woodrow Wilson believed the threat was "an absolute isolation … that brings a nation to its senses".

The League of Nations was created in 1920 with the power to impose sanctions on countries that broke international law. In its early years, there were a couple of successes: potential incursions by Greece and Yugoslavia into neighbouring states were halted by the League's threat to shut off their external trade. The real test came in 1935 when Italian Prime Minister Mussolini invaded Ethiopia. All but six of the League's 58 members deployed sanctions against Italy. They throttled exports in order to reduce the country's access to foreign exchange reserves and limit its capacity to wage war. Yet after several months of fighting, Mussolini's army entered Addis Ababa and the sanctions were lifted.

There are several lessons to be learnt from this failure. First, economic weapons are less effective when deployed against large states. Second, the early advocates of sanctions, such as Wilson, had a naïve view of human nature. They believed that populations would desist from aggressive actions when their material interests are threatened. The unfortunate truth is that nations and their rulers, especially autocratic ones, sometimes have other priorities. Third, incomplete economic blockades are ineffective. Both the United States and Germany remained neutral during the Italo-Abyssinian War and the League failed to cut off Italy's oil supplies.

Mussolini's isolation on the world stage pushed him into Hitler's arms. Germany and Japan, fearing that the economic weapon would next be deployed against them, accelerated their search for self-sufficiency in raw materials. In Germany's case, this meant pushing further into Central Europe, annexing Austria in 1938 and the whole of Czechoslovakia the following year. Hitler even told a foreign diplomat in 1939 that he needed Ukraine so that Germans would never be starved again. Japan's desperate need for oil eventually brought it into conflict with the United States. Thus, the sanctions against Italy hastened the onset of World War Two.

Now Putin's Russia is the international outcast. Unlike Italy, the country's abundant natural resources make it extraordinarily resilient to external economic pressure. In fact, sanctions were first used against Russia after the Bolsheviks seized power in 1917 in what Mulder calls a form of "counter-revolution on the cheap". The new regime withstood this economic siege and even used its monopoly on trade to withhold commodities from Europe, just as Russia today is keeping Ukrainian wheat from reaching foreign markets. By the early 1930s, when the Soviets ceased almost all trade with the outside world, Russia's autarky was complete.

International opposition to Putin is also far from unanimous. According to international trade expert Simon Evenett, for every country sanctioning Russia there are three that are not, among them China and India. Roughly half of Russia's exports go to these countries, whose export share has risen sharply over the past decade. Furthermore, Europe remains dependent on Russian energy. Over the past three months, Russian imports have fallen faster than exports, producing a record trade surplus. Even though Western countries have seized Russia's currency reserves, the rouble has strengthened against the US dollar. Evenett calculates that a European ban on imports of Russian energy would permanently lower its GDP by just 1%.

At the start of World War One, Russia accounted for around a quarter of French overseas investments. President Georges Clemenceau imposed sanctions in a forlorn attempt to get the Bolsheviks to honour obligations agreed by the previous Tsarist regime. Times have changed. Washington is now actively forcing a Russian default by forbidding Western banks from receiving payments from Moscow. Russian stocks and bonds owned by foreigners have been marked down to zero. Multinational companies including McDonald's, Renault, British American Tobacco, Heineken and BP are selling their Russian operations at fire-sale prices.

It's hard to see how writing off hundreds of billions of dollars of foreign investments in Russia will persuade Putin to change his behaviour. Still, these remarkable events highlight another unwelcome feature of sanctions: they remove traditional legal protections afforded to private property, exposing investors to arbitrary state depredations. Early critics of economic restrictions had an even more worrying concern. Sanctions, they said, blur the line between the state of war and that of peace. It's not clear at what point a sanctioned nation will consider an extra punishment to be an act of war. Billionaire investor George Soros told the Davos audience this week that, in his view, World War Three was already under way.

The longer-term danger is that the invasion of Ukraine and the accompanying Russian sanctions, like those imposed on Italy in the mid-1930s, will provide a further impetus to deglobalisation, driving Russia into China's camp and upending the US dollar-based financial system. Evenett warns that the advent of a multipolar world could result in yet more stranded assets for Western investors. This is not a desirable outcome, but a chain of events has been set in motion that may make it unavoidable.