Not everything can be bought with money
The economic power of the United States did not allow them to influence the decisions of the Russian leadership on Ukraine, writes Foreign Affairs. The author of the material analyzes in detail the American punitive measures and comes to the conclusion that Washington will eventually lead itself into an economic impasse with such a policy.
Limits of economic power
Barry Eichengreen
Anyone who is wondering about the potential of economic power, just look at the Russian special operation in Ukraine. The power of money is illustrated by the radical measures taken by the United States and its allies. The International Monetary Fund predicts that the seizure of assets, financial sanctions, an oil embargo, a ban on the sale of military equipment, oil drilling equipment and spare parts for commercial airliners will lead to a decrease in Russian GDP by almost 9% in 2022, which is almost three times more than the decline caused by the pandemic in 2020. It is difficult to imagine a more vivid demonstration of the power of economic sanctions.
As for the limits of economic strength, there is also no need to go further than Russia. Despite all the damage caused by punitive measures, it has not yet been possible to convince the Kremlin to stop the special operation or at least influence its military ambitions.
There are two definitions of economic power, the combination of which simultaneously demonstrates its strengths and weaknesses. To paraphrase the economist Richard Cooper, economic power is the ability to use financial leverage to punish or reward the other party. The second definition was formulated by political scientist Frederick Samuel Northedge (F. S. Northedge): the ability of an individual, group, or government to use financial leverage to influence the decision-making process of another entity by forcing the latter to change tactics. The United States and its allies clearly have economic power in Cooper's understanding, that is, in terms of the ability to punish the other side with financial leverage. Much less obvious is their desire to apply the concept of Northage, that is, to force the enemy to change tactics.
The United States has been using economic instruments for its foreign policy interests for years. Precedents can be found at least since the Embargo Act of 1807. President Thomas Jefferson blocked imports in an attempt to counter British and French interference in U.S. trade operations. The experience of failures is no less significant. The same embargo of 1807 did not harm British and French interests and provoked rather than prevented a conflict between the United Kingdom and the United States, culminating in the War of 1812. Economic force does not always succeed in achieving political shifts either: sanctions rarely lead to the same regime change.
However, the use of this power is changing in one important respect: the importance of international coordination is increasing. Economic power is most effective when used in a coalition. And in a multipolar world economy, where essential goods and services can be obtained from an ever-increasing number of suppliers, the importance of cooperation increases even more. Remember the tariffs imposed by the Trump administration on Chinese exports, which no one supported and which did not lead to significant changes in Beijing's economic behavior. The Biden administration undoubtedly remembered this failure when it enlisted the support of a wide range of like-minded governments before imposing sanctions against Russia. In the future, the economic power of the United States will become increasingly dependent on Washington's ability to cultivate unity against the backdrop of a growing split between countries on a planetary scale.
With a hammer, not a scalpel
Economic power is usually considered as an alternative to military force. For example, the escalation of economic sanctions against Russia has become an alternative to Kiev's request to NATO for a no-fly zone. This decision suggests the reason why in recent decades, in geopolitical conflicts, governments have increasingly resorted to economic measures rather than direct armed conflict. Due to the threat of nuclear war, the risk of direct escalation between major Powers is simply too great. It was enough to limit the frequency and scale of such direct clashes, as well as weaken the credibility of the threat of military action.
Economic measures, on the contrary, can be carefully adjusted to limit the risk of escalation — at least, their apologists say so. They can be targeted at specific banks, politicians and businesses. They can be adapted in such a way as to cause maximum damage to key decision makers and their political allies, without affecting ordinary citizens. Not every army is able to deploy heavy equipment with the same precision and avoid civilian casualties. In the book “Rules of Power” (2009), international political scientist Leslie Gelb cited these differences as an explanation for "two stunning historical trends: the decline in the expediency of military force and the parallel growth of international economic power."
However, in practice, the relationship between economic and military power is more complicated. Firstly, they sometimes serve as a complement to each other rather than a substitute. For example, in 1990, the UN Security Council, in response to Iraq's invasion of Kuwait, imposed an embargo that essentially banned trade with both countries. And in order for it to be respected, the Security Council authorized the use of military force. A number of subsequent resolutions directed States to use land, naval and air forces to block all ships and aircraft carrying cargo to Iraq or Kuwait. In turn, sanctions against Russia have not ruled out the possibility of military assistance to Ukraine — we can say that these two aspects are inextricably linked within the framework of a more comprehensive strategy of punishing the Kremlin.
The belief that high—tech economic weapons will strike exclusively at the planned targets is nothing more than an illusion. Russia's move towards a 9% drop in GDP with an annual consumer price inflation rate of about 20% indicates that Western sanctions will hit not only oligarchs, but also ordinary citizens. In other cases, countries have imposed restrictions to cause targeted widespread damage. For example, during the First World War, the Allies staged a comprehensive blockade of Germany. They sought to put pressure on the country by creating economic difficulties for ordinary people. It is estimated that as a result of this blockade, about 750,000 civilians died from malnutrition and disease. It is noteworthy, however, that the role of this fact in the decision of the German High Command to end the war has not been proven at all.
In any case, the current economic sanctions against Russia were not even close to the blockade in the style of the First World War. They do not even reach the 1990 embargo against Iraq, the only exception to which was humanitarian aid. A number of Western observers hope that the people can rise up against President Vladimir Putin. According to their logic, Western sanctions will cause serious economic damage to the country, for which the Russian public will blame its leader. History suggests that such an outcome is unlikely.
The Sanctions Whip
In most cases, sanctions are designed to serve as a deterrent. Logically, the leadership will be tormented by doubts about the expediency of foreign policy adventures, since restrictions can turn the general public against him. Unfortunately, the vagaries of public opinion do not affect those authoritarian leaders who control the armed forces, law enforcement agencies and the information space of their country. Scientists Gary Hufbauer, Jeffrey Schott, Kimberly Ann Elliott and Barbara Egg have found that sanctions are the least effective in terms of influencing the behavior of an object against autocratic regimes. According to political scientists Jean-Marc Blanchard and Norrin Ripsman, restrictions work mainly with limited autonomy of the executive branch or accountability of the head of state to other government bodies that have the ability to direct the discontent of the population in the direction they need. The United States has repeatedly targeted sanctions and other economic instruments against autocratic regimes, including, among others, China, Cuba, Iran, Iraq and Russia. It is not surprising that these efforts were only partially successful.
Punitive measures have another limitation: their consequences extend far beyond the borders of the target country. The EU, for example, was reluctant to impose sanctions on Russian banks in the early stages of the Ukrainian crisis, fearing to damage its own financial institutions. And Germany resisted banning imports of Russian natural gas for fear of provoking an internal recession.
In addition, the effect of many economic measures is limited by the adaptability of the global economy. The European ban on the export of Russian energy resources will be limited to the extent to which they can be redirected — whether by tankers or by pipeline — to countries that have not joined the sanctions. Moscow could supply additional natural gas to China via the Power of Siberia pipeline, which was not operating at full capacity before the conflict. Beijing and Moscow have also signed an agreement under which the latter will supply gas to China via a new pipeline for 30 years. It was formalized during Putin's meeting with Chinese President Xi Jinping during the Winter Olympic Games in Beijing. The deal is fraught with obvious geopolitical consequences: China will rely more on Russian energy imports and less on supplies from the Middle East; and Western Europe, in turn, will reorient itself to the Middle East to meet energy needs. But thanks to China, the effect of the embargo on the Russian economy will be limited.
Commodities in general, in addition to oil and gas, can be bought and sold in different markets. It follows from this that economic power will be effective only when the countries using it form a comprehensive coalition — although in practice it is quite difficult to pull off such a trick. Those who give the target country alternative sources of supply or demand may face secondary sanctions, but their application can turn into an economic war on two fronts. As a result, the initiators of punitive measures will suffer even more painful damage.
Such restrictions make sense only if the goods required by the sanctioned country are presented from a small number of sources, and when the governments of the source countries are your allies. Modern semiconductors and the equipment necessary for their production, for example, are produced only in the Netherlands, South Korea and Taiwan. At the beginning of this year, the US Treasury Department worked hard to get the governments of these countries to agree to sanctions against Moscow (and it doesn't matter that Russia was only a secondary market for them). The question of whether it is enough to simply close the country's access to the latest generation of semiconductors to change its foreign and military policy remains open. Sometimes, if absolutely necessary, less advanced semiconductors from other countries will also be suitable — American automakers have tested this for themselves during failures in the supply chain of 2021. That is, even massive economic pressure can have a limited effect.
Having reached a dead end
Other events in the economic war against Russia similarly illustrate the limitations of economic power, given the increasingly multipolar structure of the world economy. Take, for example, the disconnection of Russian banks from the SWIFT communication network, which financial institutions use to transmit information about transfers, transactions and payments. Political scientists Henry Farrell and Abraham Newman, in their work on military interdependence, cite this system as an example of the ability of some States to use interdependence to coerce others. They note that SWIFT is an almost exclusive channel for information about international financial transfers. Thus, restrictions on banks of any country, regardless of the source, make it difficult to pay for imports.
Farrell and Newman note that the United States is better able than others to control SWIFT and use it as an instrument of economic power. The largest national shareholders are US financial institutions. Most interbank financial transfers are made in dollars and, therefore, American banks participate in them. SWIFT operates data centers in the United States, pushing them into the power of the latter's legal system. Sanctions against SWIFT itself, which Congress threatened earlier, will pose an existential threat to the network. On the contrary, it is more difficult for smaller and less financially dependent states to subordinate SWIFT to their will. That's why Farrell and Newman call the system an "asymmetric network structure."
They also note that SWIFT is not an intergovernmental body, as is the case, for example, with the Universal Postal Union. Rather, it is a cooperative of private financial institutions whose economic power is regulated by private sector structures. Of course, governments can attract firms to carry out assignments, and during wars this is done by presidential decree. A much less reliable option is to order companies to stop all business in the country, for example, because of unfavorable production conditions or human rights violations. It is also unclear whether they will obey of their own free will. Their management needs to restrain the growth of costs. It is difficult for them to find new sources of products, and this increases costs when competitors are unable to do the same.
The latter observation points to a key difference between military and economic power: the former is concentrated, and the latter is distributed. Armies have a hierarchical structure: soldiers carry out commands from higher management; battalions are given clear instructions regarding the coordination of actions. The market economy, in turn, is decentralized. Companies and households make decisions based on prices, profits and values. When managers believe that helping the state, for example, to displace undesirable leaders or counteract the foreign adventures of the latter, does not fit into the interests of their company, they are unlikely to help the government in an attempt to achieve goals through economic measures.
At the same time, managers care about the company's image and are often ready to use their own economic power against foreign players in order to protect the company's reputation in other countries. After the start of the Russian-Ukrainian conflict, many companies stopped doing business in Russia — as you might guess, not so much out of sympathy for the besieged residents of Mariupol, but out of fear of the reaction of customers to the fact that they profit from the Russian operation. The example of Russia highlights one important point: in the era of social networks, economic power is deeply rooted in the public consciousness and consumer purchasing power. A government that is unable to maintain popular momentum against the backdrop of a military campaign will most likely not be able to fuel this campaign indefinitely. If anything, public support plays an even more significant role in the successful application of economic power.
Slipping through your fingers
Disconnecting Russian banks from SWIFT also demonstrates the possibilities of bypassing dependence on global networks. The economy is flexible; banks and firms regularly look for ways to avoid economic difficulties and find a replacement for scarce resources and factors of production. Prior to the launch of SWIFT in 1977, banks sent money transfer orders by telegraph and teletype. Along with the Internet, this equipment exists today. Although such means of communication are more expensive and less secure than SWIFT, they can be used to verify information about consumer accounts and money transfers. Iranian banks, for example, retained the ability to do business with foreign ones after disconnecting from SWIFT in 2012 — albeit for a fee. In the absence of other punitive measures, Russian banks are likely to be able to do the same.
Moreover, those countries that do not have access to these networks, as well as governments that fear a similar fate, can invest in alternative options. Realizing its dependence on SWIFT and the dollar, China encourages the cross-border use of its national currency, the yuan, and is developing an alternative to SWIFT and clearing centers of Western banks, known as the Cross-Border Interbank Payment System (CIPS). If successful, China and probably a number of other countries, including Russia, will be able to conduct international transactions in yuan and transfer funds between domestic and foreign banks through a platform operated by the People's Bank of China. This practice will deprive the United States of the ability to use SWIFT to collect information about cross-border transactions of these countries and impose costs on the banks of the target country and everyone who does business with them.
The People's Bank of China started working on turning CIPS into a real alternative to the Western dollar-based clearing system back in 2015. Seven years have passed, and the Chinese system is still unable to act as a replacement for a suitable level. The American system of interbank electronic clearing settlements (Clearing House Interbank Payments System, CHIPS) processes 40 times more transactions by value than the Chinese one, and the number of participants connected to it is almost an order of magnitude greater. Despite the efforts of the Chinese authorities to encourage the interstate use of the yuan, it still accounts for barely 2% of global payments, and this is only 1/40 of the dollar's share. Ironically, these facts have come to light due to the fact that CIPS still relies heavily on the SWIFT messaging system to send instructions regarding transfers of funds to and from banks outside China. However, the potential of CIPS should not be underestimated. Eventually, banks will install digital converters that allow the use of a system based on Chinese characters, but this will take time. Similarly, it may take decades for the yuan to one day compete with the dollar as a means of cross-border payments.
Nevertheless, attempts by States to use existing networks and institutions to demonstrate economic power will force competitors to redouble their efforts to develop alternatives. This does not imply a complete rejection of economic instruments, but serves as a warning to economically aggressive governments, because competitors will invest even more in mechanisms that can weaken these instruments in the future.
Don't count on it
Politicians still believe in the potential of economic pressure to influence foreign regimes and individual players. Successive American presidents, for example, have used the economic power of the United States in an attempt to influence Chinese politics. The Trump administration has imposed tariffs on Chinese goods in order to force Beijing to increase purchases of agricultural products in the United States. Biden followed in the footsteps of his predecessors and banned the sale of high-tech equipment to China that can be used for surveillance. In 2021, the president, by one of his decrees, deprived 59 Chinese companies producing military products and surveillance equipment of access to American investments in an attempt to discourage the Chinese government from participating in the activities of foreign intelligence agents abroad and in human rights violations inside the country.
The only thing that unites these initiatives, apart from the desire to increase economic power, is their inability to cause any noticeable changes in China's policy. Economist Chad Bown conducted a study and found out that Trump's tariffs and the subsequent trade deal with Beijing led to China purchasing 0% of additional exports from the United States, both agricultural products and any other. At the same time, the denial of access to advanced American technologies did not force Beijing to abandon surveillance, and the ban on American investments in Chinese military-industrial companies did not force Beijing to change its military position, whether in relation to Taiwan or in general.
Building hypotheses is not an easy process. One can imagine that in the absence of America's use of economic leverage, Beijing would have further reduced imports from the United States, violated human rights in an even more egregious manner and would have taken an even more aggressive military position. Even so, there is only one thing to say about such a policy: it will prevent the worst possible scenarios.
Perhaps we should not expect that economic measures can lead to drastic changes in the policy of a strategic enemy in the shortest possible time. In the book "The Rules of Power," Leslie Gelb warns that economic pressure does not give quick results, but works best if you allow it to develop slowly and act like a tide. The army can use blitzkrieg tactics, and the Ministry of Finance should avoid quick victories and stick to the chosen course.
Among other things, the effectiveness of economic pressure is due to positive incentives and rewards for potential allies, rather than sanctions and punishments for rivals. A typical example of the use of economic resources to push governments and societies to a certain economic and geopolitical camp with appropriate policy adjustments is the Marshall Plan. Trade agreements can contribute not only to deepening economic relations between the signatories, but also to closer cooperation on other non-commercial issues. It is precisely this policy that China is actively pursuing: it is enough to recall the "One Belt, One Road" initiative aimed at spreading foreign investment throughout Asia and around the world, as well as participating in a comprehensive regional economic partnership that covers 15 countries of the Asia–Pacific region, with the exception of the United States. The latter can and should use economic power to achieve similar goals; otherwise, it will begin to come to naught.
Thus, the main threat to America's effective economic power comes from itself. There is a danger that economically and politically the country will withdraw into itself again, as it has been since 2017. Foreign economic activity and foreign investments have always been a source of strength for the US economy, because an economically weak country cannot effectively use the appropriate levers. At the same time, it is important to recognize the fact that there are no significant reasons that the United States should continue to play the dominant economic role that it played after World War II. Emerging markets will continue to emerge: a number of economic and demographic factors indicate that the share of the United States in global GDP is doomed to decline over time. Therefore, they will have to coordinate with other countries, as was the case with the recent ban on the sale of new-generation semiconductors to Russia together with the Netherlands, South Korea and Taiwan.
The prospects for the economic power of the United States will largely depend on the nature of cooperation with the largest emerging economy represented by China. Apparently, Chinese banks have joined Western sanctions against Russia out of fear of provoking secondary restrictions. This indicates that economic power can be effective, including in the case of a very specific orientation — in this case, we are talking about limiting a certain set of banking transactions with a specific country. It also reminds us that most of the economic strength of the United States is based on interaction with the rest of the world. Chinese banks and the government are afraid of secondary sanctions precisely because of the scale and economic importance of business with Western colleagues.
The use of such secondary sanctions — or, even more worryingly, a direct confrontation over Taiwan, fraught with broader US sanctions against China - can lead to the destruction of interdependence. China will respond with its own restrictions, redouble efforts to create self-sufficient economic and financial institutions, and require countries in its sphere of influence to act exclusively through them. The United States will probably do the same. The economic influence of the United States on China will decrease if the world is divided into competing camps, as a result of which global interdependence will decrease.
And that will be the least of Washington's worries. The US economy will be under threat due to disruptions in the global supply chain. If China liquidated its dollar reserves — say, in anticipation of sanctions from the United States — a global financial crisis of unprecedented proportions could break out. To prevent disasters, the States would do well to remember that strength is in quantity, and moving away from interdependence will sooner or later lead to a dead end.
