Strength in unity: The economic cost of trade restrictions on Russia

François Langot, Franck Malherbet, Riccardo Norbiato, Fabien Tripier 22 April 2022

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Editors' note: This column is part of the Vox debate on the economic consequences of war.

In the aftermath of the invasion of Ukraine by Russia, the first sanctions from the EU and the international community were diplomatic and financial. The continuation of the war has led a number of countries to broaden the scope of sanctions towards trade sanctions. While these sanctions are unprecedented, they are clearly insufficient insofar as the Russian economy continues to enjoy a steady stream of revenue from oil, gas, and coal sales. According to Eurostat, Russian energy imports by the EU were around €99 billion in 2021 and accounted for 62% of imports from Russia. With the war, the price of energy has soared. Today, the EU pays Russia about €640 million per day for oil and €360 million for piped natural gas. This should be compared to the cost to Russia of one day of war in Ukraine, estimated at $0.65 billion (Center for Economic Recovery 2022). Undoubtedly, the EU's energy dependence on Russia is its Achilles heel and is Russia's most powerful economic lever. This must stop.

Massive evidence of war crimes in northern and eastern Ukraine is reshuffling the deck and putting pressure on EU countries to wean themselves off Russian energy. On 8 April, the EU adopted its fifth package of sanctions against Russia including a ban on coal and solid fossil fuels. Should we go further in the embargo and extend it to Russian gas and oil? This issue is being debated as part of a new sanctions package that divides the EU27. The reluctance to impose an embargo on Russian energy is based on the idea that there would be no alternative to Russian energy for firms and households. This lack of substitution would result in a very high cost for the EU and potentially higher than that borne by Russia. This extreme view, which has already been criticised by Bachmann et al. (2022a, 2022b), neglects the possibilities of substitution at the different stages of economic activity, and would result in a decrease in production strictly equal to the amount of forgone energy. Fortunately, the reality is less simplistic: energy substitutes can be found by firms, or intermediate goods that do not use energy (or are less energy intensive) can also be offered by new suppliers. In addition, consumer demand can move towards other goods if this energy-based good becomes too expensive or no longer meets needs. History is full of examples in which such substitution mechanisms are put in place (Bachmann et al. 2022a, 2022b). 

How can we assess the economic effects of the embargo taking into account all the possibilities of substitution and price adjustments on all markets? An inherent difficulty with this type of assessment is that an embargo policy changes the global production chain with cascading effects specific to each country. The model developed by Baqaee and Fahri (2021) proves to be of great relevance here. Based on this model, teams of researchers have recently tried to quantify the effects of an embargo on Russian imports at the EU level for Germany (Bachmann et al. 2022a, 2022b), France, and a broader set of countries (Baqaee et al. 2022, Langot and Tripier 2022). The average cost of the embargo in the EU is equivalent to a -0.7% reduction in gross national expenditure (GNE) (household consumption, investment, and public spending) per year and per capita, with a strong heterogeneity going from -5.3% for Lithuania to +0.2% for Luxembourg. Germany and France occupy intermediate positions with losses of around -0.3% and -0.2%, respectively. In concrete terms, the average cost per year and per capita would be about €535 for a Russian and €230 for a European.

In what follows, we complement the previous contributions by studying the cost to Russia of trade sanctions according to their intensity. The intensity of sanctions varies according to the number of countries applying them and whether they affect imports only or both imports and exports. From a very short-term perspective, we assume that it is very difficult to substitute inputs with other inputs: the elasticity of substitutions retained being three times lower than the usual estimates, a very conservative assumption. We then consider six different scenarios. The first two concern only imports and focus on an embargo by the EU and countries ‘unfriendly’ to Russia.1 In these first two scenarios, we assume a strict embargo on all imports from Russia (including energy). We retain this strategy because, in addition to energy (coal), the new EU sanctions ban imports of many other commodities and products such as wood, fertilisers, cement, rubber products, and so on.2 This leads to an overestimation of the cost of an embargo against Russian energy in the strict sense, but is closer to the current state of the sanctions. The last four scenarios involve both imports and exports, i.e. a total exclusion from trade relations with Russia for the countries behind the sanctions. Compared to the first two scenarios, these are more realistic in that they also take into account the export restrictions that are part of the sanctions package. For example, the fifth set of restrictive measures against Russia prohibits the export of many high-tech products on which Russia is highly reliant, such as quantum computing, advanced semiconductors, or sensitive machinery.3 Figure 1 represents the cost to Russia of trade restrictions for the six scenarios. The cost increases sharply with the extent of the restrictions.

Figure 1 Costs for Russia of international trade restrictions (as a percentage of GNE)

Notes: This figure presents the cost for Russia of international trade restrictions under six different scenarios as a percentage of Gross National Expenditure (GNE). (I) trade restrictions are for imports only; (I&E) trade restrictions are for both imports and exports. For example, World - [China, India] (I&E) indicates that trade restrictions are taken at the world level excluding China and India and concern both imports and exports.

Thus, when the sanctions concern only imports and are taken at the level of the EU, the GNE decreases by 2.27%, whereas when they concern both imports and exports and when international coordination is perfect, national expenditure decreases by 33%. The cost for Russia is thus 14 times larger. This last scenario is obviously unrealistic but shows that international coordination is very important. In the more restricted and politically realistic framework where Russia is excluded from international trade with the exception of China and India, the drop in GNE is still of a considerable magnitude and would be about -28%. This shows that there is strength in unity. Finally, in the more realistic case where restrictions are coordinated at the level of unfriendly states, the loss is -11.29%, five times greater than when the EU acts in isolation.

The European Commission, which is in charge of drafting a new set of sanctions, is seeking to further restrict imports from Russia, especially for oil and gas. Some countries, including Germany and Austria, are opposed to this new round of sanctions on the grounds that they would be too costly because of their heavy dependence on Russian energy. Figure 2 represents the cost for the EU of trade restrictions for the six scenarios. 

Figure 2 Costs for the EU of international trade restrictions (as a percentage of GNE)

Notes: This figure presents cost for the EU of international trade restrictions as a percentage of Gross National Expenditure (GNE). (I) trade restrictions are for imports only; (I&E) trade restrictions are for both imports and exports. For example, World - [China, India] (I&E) indicates that trade restrictions are taken at the world level excluding China and India and concern both imports and exports.

It appears that the costs borne by the EU are significantly smaller than those borne by Russia, whatever the scenario. Moreover, these costs are globally stable and represent an average loss of 0.77% in GNE. Thus, the international coordination of sanctions implies a much higher cost for Russia, but more importantly, it implies almost the same (and affordable) cost for the EU. Table 1 summarises the results of our simulations.

Table 1 Costs for Russia and the EU of international trade restrictions (as a percentage of GNE)

Notes: This table presents costs for Russia and the EU of international trade restrictions as a percentage of Gross National Expenditure (GNE). EU and UC stand, respectively, for European Union and Unfriendly Countries. 

The relative cost of sanctions increases significantly as international coordination strengthens. Bachman et al. (2022a, 2022b) correctly point out that the estimated costs of the embargo based on the Baqaee and Fahri (2021) methodology may be underestimated, in part because of price rigidity or the omission of some factor reallocation costs. However, to the extent that these additional costs are common to all countries, there is no reason to believe that they would substantially affect the relative costs of an embargo. In the most restrictive scenario, an embargo would cost Russia three times as much as it would cost the EU, while in the most extreme scenario it would cost Russia 41 times as much. Finally, in the more realistic case of coordination at the level of unfriendly states, the cost would be 13 times higher for Russia.

As the European Commission discusses a sixth round of sanctions, will the democracies decide on an embargo on Russian oil and gas? While the US seems to favour this option, disagreements are more pronounced within the EU because of greater energy dependence. Based on the most recent developments in international macroeconomics, our evaluations show that the losses for Russia are more important and out of proportion to those for the EU, which remain manageable in relation to the stakes. More importantly, our results show that the effectiveness of sanctions depends crucially on international coordination. The adage that there is strength in unity has never been more relevant. 

References

Bachmann, R, D Baqaee, C Bayer, M Kuhn, A Löschel, B Moll, A Peichl, K Pittel and M Schularick (2022a), “What if? The Economic Effects for Germany of a Stop of Energy Imports from Russia”, ECONtribute Policy Brief 28/2022.

Bachmann, R, D Baqaee, C Bayer, M Kuhn, A Löschel, B Moll, A Peichl, K Pittel and M Schularick (2022b), “What if Germany is cut off from Russian energy?”, VoxEU.org, 25 March.

Baqaee, D and E Fahri (2021), “Networks, barriers, and trade”, NBER Working Paper 26108.

Baqaee, D, C Landais, P Martin and B Moll (2022), “The Economic Consequences of a Stop of Energy Imports from Russia”.

Center for Economic Recovery (2022), “Daily brief”, 11 April.

Langot, F and F Tripier (2022), “Le coût d’un embargo sur les énergies russes pour les économies européennes”, Note de l’Observatoire Macro, 2022-2.

Wolff, G B (2022), “The EU without Russian oil and gas”, Bruegel, 5 April.

Endnotes

1 According to the TASS agency, the list of countries unfriendly to Russia includes the US, Canada, the EU states, the UK, Ukraine, Montenegro, Switzerland, Albania, Andorra, Iceland, Liechtenstein, Monaco, Norway, San Marino, North Macedonia, and also Japan, South Korea, Australia, Micronesia, New Zealand, Singapore, and Taiwan. For further details see https://tass.com/politics/1418197

2 See the fifth sanctions package at https://ec.europa.eu/commission/presscorner/detail/en/IP_22_2332

3 Russia imports about €17 billion a year in high-tech products, nearly two-thirds of which come from the EU and the US (Wolff 2022). See also https://ec.europa.eu/commission/presscorner/detail/en/IP_22_2332

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Topics:  International trade Politics and economics

Tags:  Ukraine war, Russia, embargo, sanctions, energy, production network

Professor of Economics, Le Mans University

Professor of Economics, Paris Graduate School of Economics, Statistics and Finance (ENSAE)

PhD student in Economics, CREST-Ecole Polytechnique

Professor of Economics, Université Paris Dauphine - PSL

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