Extraterritorial sanctions: A stick and a carrot

Ohyun Kwon, Constantinos Syropoulos, Yoto Yotov 04 March 2022

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“Sanctions are now a central tool of governments’ foreign policy” (The Economist 2021), with the number of both new and existing sanction cases increasing steadily since the middle of the last century (Figure 1). The increase in the number of sanctions and the evolution in their forms (e.g. ‘smart’ sanctions) and objectives (e.g. to defend human rights) have been matched by significant academic and policy interest. While the debate on whether sanctions are successful in achieving their objectives is still unsettled (Hufbauer et al. 2007, Bapat and Morgan 2009, and Kirilakha et al. 2021), there is ample quantitative evidence – and a broad consensus among academics and policymakers – that the effects of sanctions on the sanctioned states (the targets), on the sanctioning states (the senders), and on the economic relationships between the senders and the targets are significant (van Bergeijk 2012, 2021, Bělín and Hanousek 2019, Hufbauer and Jung 2020, Felbermayr et al. 2021).

Figure 1 The evolution of sanction cases, 1950-2019

Note: This figure is from Kirilakha et al. (2021), who use The Global Sanctions Database (GSDB) to trace the evolution in the number of new (i.e., newly discovered) and existing (i.e., previously discovered) sanction cases during the period 1950-2019. 

In addition to their primary (direct) effects on the trade and trade costs between target and sender states, economic sanctions have been scrutinised for their extraterritorial (secondary) effects on third countries (e.g. on the trade and trade costs between third countries and the countries that are involved in the sanction).1 There is plenty of anecdotal evidence for extraterritorial sanction effects on firms and individuals (Atlantic Council 2019). Moreover, the extraterritorial sanction effects have been extensively covered by the popular press (Shahla et al. 2021), policy reports (European Parliament 2020), international discussions,2 political threats,3 and academic articles (Jaeger 2021). Still, to our knowledge, systematic quantitative analyses of the effects of extraterritorial sanctions are missing.

In a new paper (Kwon et al. 2022), we aim to fill part of this gap by quantifying the extraterritorial impact of sanctions on trade and welfare. To perform the analysis, we rely on the widely used structural gravity model, which delivers both our partial and standard general equilibrium (GE) results. We employ two recent data sets: (1) the Structural Gravity Database of the World Trade Organization (Larch et al. 2018) for trade flows, and (2) the Global Sanctions Database (Kirilakha et al. 2021) for sanctions.  

The extraterritorial effects of sanctions are large and heterogeneous

Our econometric analysis relies on the latest developments in the empirical gravity literature (Yotov et al. 2016) and delivers four main findings.

First, we obtain a negative and statistically significant estimate of the extraterritorial impact of sanctions on trade. Capitalising on the structural properties of our model, we estimate that, on average, the extraterritorial impact of sanctions is equivalent to an 1.28% reciprocal tariff equivalent on trade between the countries that are involved in the sanction and third countries. 

Second, we obtain a large, negative, and statistically significant estimate of the extraterritorial impact of sanctions on trade among targets and third countries. The corresponding reciprocal tariff equivalent is 1.33%. While this number may seem relatively small, we note that this effect is equivalent to an average tariff imposed on the exports and imports of the target versus all countries in the world, other than the sender. Thus, the impact on the target’s trade is sizeable.

Third, we obtain a positive and statistically significant estimate (a reciprocal tariff-equivalent of -1.7%) of the extraterritorial impact of sanctions on trade among senders and third countries. We emphasise that this favourable estimate is obtained while we control for all possible trade diversion GE forces in our econometric model. Thus, our result implies that sanctions bring about a reduction in bilateral trade costs among senders and third countries.

In combination, the opposing estimates of the extraterritorial effects of sanctions on trade of targets versus senders reveal that, while the extraterritorial burden of sanctions is borne by the targets, the effect on senders' trade with third countries is actually positive. The latter finding, which is intriguing, may shed new light on the motivation of senders to impose sanctions. For example, it raises the possibility that a sender's rationale for pressuring third countries to impose sanctions may not be just inflict pain on target states but also to enjoy gains in trade and welfare. Another implication of our estimates is that the impact of sanctions on third-country trade and welfare may be positive too. 

Finally, we confirm that the primary impact of sanctions on trade costs between senders and targets is large and statistically significant (a tariff-equivalent of 7.55%). In addition, an important implication of our analysis is that if the extraterritorial sanction effects are not properly accounted for in the empirical model, the estimates of the primary sanction effects on trade between targets and senders may be significantly biased (e.g. by 20% in our sample). 

The extraterritorial welfare effects of the US sanction on Cuba

We also demonstrate that the extraterritorial component of sanctions has significant welfare implications for targets, senders, and third countries. To this end, we use a benchmark new quantitative trade model to translate our econometric estimates of the primary and extraterritorial sanction effects into GE welfare effects of the US sanction on Cuba. We focus on this sanction because it is a well-known, long-lasting, and one of the most comprehensive trade embargoes in the world (Moerhr 2019, Jaeger 2021), whose extraterritorial effects have been the object of controversy and heated political exchange.4 Yet, there is no systematic quantitative evidence for its extraterritorial consequences. 

The broad conclusion from our counterfactual GE analysis is that the extraterritorial sanction effects may lead to significant changes in the welfare of targets, senders, and third countries. 

For targets, our main finding is that, if the extraterritorial sanction effects are not taken into account, the estimates of the negative welfare effects on the targets are likely to be greatly underestimated. For example, when the extraterritorial effects of the US sanction on Cuba are added to the primary effects on the target, the negative impact on Cuba's welfare rises by 50% (from a loss of 1.27% to a loss of 1.84%). 

For senders, interestingly and in sharp contrast to standard analysis and conventional wisdom, the extraterritorial sanction effects prove beneficial; that is, the imposition of sanctions may enhance senders’ welfare. In the case of the US sanction on Cuba, our estimates suggest a small but positive welfare increase of 0.09% for the US. This welfare improvement is driven by the increase in US's trade with third countries, which outweighs the loss due to reduced trade with Cuba. 

Finally, we find that, owing to its extraterritorial impact on trade, the US sanction on Cuba has generated significant welfare effects for third countries that vary between -0.009% and 0.62%. Based on the magnitudes and variation of our estimates, we conclude that the direction and size of the welfare effects on third countries depend on three key determinants: the size of the target, the size of the sender, and the nature of the economic links among the three countries/regions. In particular, third countries could suffer welfare losses due to trade diversion from the target country. However, they could also enjoy welfare gains from possible increase in trade with senders. As a result, the net effect on third-country welfare is ambiguous.

Implications for policy analysis and further research

We demonstrate that the extraterritorial impact of sanctions on trade and welfare is significant. Therefore, these effects should be taken into account ex ante, when sanctions are imposed, and ex post, when the total impact of sanctions is evaluated. We also believe that our analysis may motivate additional research and be extended in several promising directions. 

From a policy perspective, it is possible within our framework to refine the econometric analysis to zoom in on specific sanctions, countries, and sectors. From a GE perspective, the model could be extended to capture the links between extraterritorial sanctions, global value chains and structural change. Furthermore, our work could serve as a springboard for research on the motives and objectives associated with the imposition of sanctions, and to cast fresh light on the question of how national economic developments (e.g. trade and growth) affect political behaviour of sovereign states, economic regions, and formal alliances.

References

Bapat, N A and T C Morgan (2009), “Multilateral versus unilateral sanctions reconsidered: A test using new data”, International Studies Quarterly 53(4): 1075-1094.

Bělín, M and J Hanousek (2019), “Making sanctions bite: The EU–Russian sanctions of 2014”, VoxEU.org, 29 April.

European Parliament (2020). Extraterritorial sanctions on trade and investments and European responses. Doi:10.2861/028506, ISBN: 978-92-846-7473-2. 

European Union (2019). “Joint statement by Federica Mogherini and Cecilia Malmström on the decision of the United States to further activate Title III of the Helms Burton (Libertad) Act”, Delegation of the European Union to Cuba, Bruxelles. 

Felbermayr, G, A Kirilakha, C Syropoulos, E Yalcin, and Y V Yotov (2021), “The ‘Global Sanctions Data Base’: Mapping international sanction policies from 1950-2019”, VoxEU.org, 18 May.

Hufbauer, G C and E Jung (2020), “What’s new in economic sanctions?”, European Economic Review 130(C). 

Hufbauer, G C, J J Schott, K A Elliott, and B Oegg (2007), Economic sanctions reconsidered,  Washington, DC: Peterson Institute for International Economics, Third edition.

Jaeger, M (2021), “Circumventing sovereignty: Extraterritorial sanctions leveraging the technologies of the financial system”, Swiss Political Science Review 27 (1): 180–192. 

Kirilakha, A, G Felbermayr, C Syropoulos, E Yalcin, and Y V Yotov (2021), The global sanctions data base: An update to include the years of the Trump presidency, in P A G van Bergeijk (ed), Research Handbook on Economic Sanctions: 62-106.

Kwon, O, C Syropoulos, and Y V Yotov (2022), “The Extraterritorial Effects of Sanctions”, Drexel Economics Working Paper series.

Larch, M, J Wanner and Y V Yotov (2018), “Bi- and Unilateral trade effects of joining the euro”, Economics Letters 171(C): 230 234.

Shahla, A, P Sykes , and G Motevalli (2021). “Iran’s top nuclear diplomat to visit U.K., France, Germany”, Bloomberg, 8 November. 

Moerhr, O (2019). “US Cuba policy: EU and Canadian firms to suffer?”, The Atlantic Council, Graphics by S Hua, F Aubee, and N Brown. 

The Economist (2021), “Sanctions are now a central tool of governments’ foreign policy”, 22 April. 

van Bergeijk, P A G (2012), “Failure and success of economic sanctions”, VoxEU.org, 27 March.

van Bergeijk, P A G (2022), “The second sanction wave”, VoxEU.org, 5 January.

Endnotes

1 Importantly, the definition of ‘extraterritorial’ sanction effects should not be confused with the GE impact of sanctions on third countries. The GE effects of sanctions are present even in the absence of extraterritorial effects. Nonetheless, the extraterritorial effects have a GE dimension that may work against the ones associated with primary policies – it may even outweigh them.

2 See here.

3 See here.

4 See here, here, and here.

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Topics:  International trade Politics and economics

Tags:  sanctions, trade, extraterritorial effects, World Trade Organization, WTO, welfare effects

Assistant Professor, School of Economics, LeBow College of Business, Drexel University

Trustee Professor of International Economics, LeBow College of Business, Drexel University

Professor, LeBow College of Business, Drexel University

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