James K. Galbraith: The Gift of Sanctions – An Analysis of Assessments of the Russian Economy, 2022 – 2023

Yves here. James Galbraith politely and methodically questions some of the economic logic used to claim that the Western sanctions have done serious, lasting damage to Russia. As we and others have pointed out, readers in Russia and contacts who have even more connections to Russia say that stores are full and commerce goes on more or less as normal, with supply issues only in a few sectors like car parts.

Galbraith does not resort to anecdata, but instead points out that many of the dire claims about Russia’s performance are either not substantiated or draw incorrect inferences from data. He contends that while it is too early to tell, the sanctions may well have been beneficial to Russia by forcing reforms and restructurings (such as buying out foreign operations on the super cheap and having largely-looting oligarchs decamp) that would have been impossible otherwise.

We’ve published Galbraith’s short essay below. We strongly urge you to read his underlying, very accessible paper, which sadly is too large a file format to embed here.

By James K. Galbraith, Lloyd M. Bentsen Jr. Chair in Government and Business Relations, University of Texas at Austin. Originally published at the Institute for New Economic Thinking website

Most assessments of the effectiveness of sanctions on Russia, with some exceptions, hold them to have been highly effective. My new INET Working Paper analyzes a few prominent Western assessments, both official and private, of the effect of sanctions on the Russian economy and war effort. It seeks to understand the goals of sanctions and bases of fact and causal inference that underpin the consensus view. Such understanding may then help to clarify the relationship between claims made by Western economist-observers and those emerging from Russian sources – notably from economists associated with the Russian Academy of Sciences (RAS). As we shall see, Russian views parallel those in the West on many matters of fact yet reach sharply different conclusions.

In the most important private assessment of sanctions, Sonnenfeld et al present a stark, even lurid, case for the “devastating” effect of sanctions, of business “retreats,” and of emigration and capital flight on the Russian economy as a whole in the year since the Ukraine war escalated in late February 2022. Their case boils down to the following major propositions:

  • the fall in oil and gas export volumes hurts Russia more than its former trading partners (mainly in Europe), since Russia sold to the EU a larger share of these commodities in Russia’s exports than the share of Russian imports in the total imports of the EU. Having lost the EU market, Russia’s prospects for new customers, notably in Asia, are limited.
  • Curtailment of equipment imports, especially in high technologies, and of foreign industrial activity has had dramatic effects – for instance forcing a nearly-complete shutdown of the automobile industry in Russia.
  • Emigration of skilled personnel and departure of foreign managers, engineers, and others whom Russia “cannot afford to lose.”
  • Capital flight, emigration of “high net worth persons,” serious falls in the stock values, and other financial indicators for major Russian resource producers, alongside an argument that the value of the ruble, which rebounded quickly after a sharp drop in February 2022, is maintained only by manipulation in a low-liquidity market.

Examining each of these propositions, we find no major errors of fact. The issue in each case is one of interpretation. Specifically:

  • Russian oil and gas revenues, and net exports, rose in 2022 as higher prices offset declining volumes. But even were this not the case, the main effect of export revenues is on reserves, not on the capacity to import or current activity. Thus oil and gas revenues have little bearing on the internal functioning of the Russian economy. They do bear on the state budget, but this is a matter of Russia’s internal tax structure, which is subject to change.
  • There were major shocks to the import of consumer goods and to the domestic production of many non-durables when sanctions were escalated in 2022. However, after a period of adjustment substitutes can usually be found or produced, while the physical capital left behind by foreign enterprises exiting Russia is sold off to domestic buyers at a steep loss. This is a major transfer of wealth from foreign to Russian firms, and it opens large market spaces that were previously dominated by Western companies.
  • The effect of skills lost through emigration is unquantified and assessments do not account for the much larger inflows of personnel from Ukraine. More important, it is highly probable that the most-skilled emigrants are relatively young, and as the educational system that produced them is intact, they will be replaced in due course.
  • The financial management of the Russian economy under sanctions has seen the payment system replaced and the ruble mostly stabilized. Sanctions against wealthy individuals have a dual effect. In some cases oligarchs emigrated, losing influence within Russia. In other cases they returned and brought capital back, seeking to protect assets from seizure. The net result is to align those oligarchs who remain active within Russia with the policies and objectives of the Russian state.

By contrast with most private assessments, official statements of the goals of sanctions emphasize two narrow objectives: to undermine Russian military-industrial capacities and to “defund the war.” They do not focus on the effect on the Russian economy and civilian population.

The question of the effect of sanctions on “critical military inputs” is not one that can be answered from public sources. However, while it is possible that some key components for military goods were procured outside Russia, common sense suggests that war preparations would have included stockpiling a substantial supply – as well as reverse engineering and import substitution. Failure to take these steps would have amounted, at the very least, to gross negligence. The funding argument, as noted above, rests on a misconception. In addition, the policy of sanctioning individuals – if its goal was to bring pressure to bear on the Russian state – must be judged a failure.

A technical analysis from a senior economist at the US Treasury Department examines the effect of sanctions on Russia’s long-term economic prospects, and may be taken as representative of the official view, including, one surmises, intelligence assessments. This analysis rests on the familiar neoclassical production function: capital, labor, technology, and the burdens of state intervention. These factors, working together, are stated to have caused a “grim” decline in Russia’s prospects, such that the economy by 2030 will be 20 percent smaller than it would otherwise have been.

This application of growth theory appears to neglect two basic mainstream concepts: the profit motive and possibilities for technical substitution. By vastly reducing the presence of non-Russian firms on Russian soil, while restricting energy and other resource exports from Russia, so that resource prices within Russia have remained stable, sanctions have had a favorable effect on the potential profitability of Russian businesses. The Treasury assessment states that Russian firms will not be capable of taking advantage of this potential. But there is no evidence for this view, other perhaps than impressions of the Soviet past and the chaos of the early transition years. Such impressions are now decades out of date.

Finally, this essay reviews a recent assessment from the Russian Academy of Sciences (RAS). On matters of fact, there is a striking agreement between this assessment and the information published in the West; the sanctions are described as having “led to large-scale crisis processes that affected almost all areas of the Russian economy.” However, the RAS report notes the effective early crisis management by the Russian state, the “relatively favorable” decline of only 0.4 percent in GDP in the first half of 2022 (at an annual rate), and signs of a turnaround already in some key indicators, including business investment. The RAS report contains numerous cautions of the dangers ahead, including a blunt warning about the state budget, yet with recommendations on how the challenges can be met.

It is too early to state definite conclusions. However, a very recent Wall Street Journal analysis – coauthored by Evan Gershkovich, now detained in Russia – takes the view (expressed in the headline) that the Russian economy is “starting” to come apart. At a minimum, this logically contradicts any notion that it was collapsing already last year, under the first shock of the application of sanctions. It, therefore, undermines both the Sonnenfeld and the Treasury theses, suggesting that while the facts in those analyses appear impeccable, their conceptual underpinnings are problematic.

The contrast between the effects of sanctions on Russia and their effects on Europe is worth noting. With respect to Russia, resource prices remained stable, the internal market for Russian firms grew, physical assets were transferred to Russians at preferential rates, and financial assets were retained in the country that might otherwise have gone abroad. With respect to Europe, imported resource prices soared, markets for exports fell, physical assets had to be sold cheaply and financial assets fled to the United States. Thus one would expect improved market conditions in Russia and deterioration in Europe – and this is what we presently observe.

Could Russia have achieved such effects on its own? As late as early 2022, the Russian economy was deeply penetrated by foreign firms in virtually all sectors except the military. The oligarchs, deeply Westernized with vast investments and assets outside the country, were highly influential. Neoliberal economic ideas were prominent, with challenges from academic institutions favoring a stronger state industrial policy still at that time in a relatively weak position. The legal, political, institutional, and ideological climate would have, almost surely, prevented the Russian state from taking the steps that were imposed upon it by the sanctions.

We conclude that when applied to a large, resource-rich, technically-proficient economy, after a period of shock and adjustments, sanctions are isomorphic to a strict policy of trade protection, industrial policy, and capital controls. Such policies have been applied with success in other countries. They are policies that the Russian government could not plausibly have implemented, even in 2022, on its own initiative. Their success or failure in Russia will be determined over time. However, strong claims for the effectiveness of sanctions in this case, so far, do not appear warranted.

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  1. KLG

    Yes. Russia has enough food, fuel, and fiber for itself ad infinitum. Russian industry does not need to sell high-end automobiles and other similar gewgaws in international markets to keep its economy afloat. Russia also has more “friends” across the globe than their primary and inexplicable antagonist(s), who seem to have forgotten the truth of what Henry the K said: “To be an enemy of the US is dangerous, but to be a friend is fatal.”

  2. Lex

    Putin’s list of accomplishments is long. Perhaps the worst failing over the last 20 years was in domestic economic development. I’d argue that he’s naturally more of a foreign policy focused leader and that even in this failure he put a lot of pieces in place for domestic economic development. So it’s fascinating that the attempt to bring him down has forced him to address the major weakness he had, and one most likely to affect his political position. Sanctions in 2014 helped a lot because they forced development of responses. Russia was at least conceptually well prepared for 2022 sanctions.

    Within the last few weeks Putin have a speech saying the primary role and goal of government is to increase the public’s standard of living. Based on his domestic economic actions over the last year, he means it. And it seems clear that the Russian state (at least at the highest level) sees and plans to take advantage of the opportunities presented by the sanctions regime. That doesn’t mean it will be fully successful but it does suggest the opportunity will be leveraged to the extent possible.

    And the European relationships will come back. When they do though the balance of power will be different.

    1. Yves Smith Post author

      HUH? Please go read the chapter on Death of a Nation (embedded at the end of this post) and get back to me.

      Russia had had a decade of economic collapse when Putin took over. GDP per capita has increased over 5x under Putin, an unheard of accomplishment. Putin’s standing with the Russian public is based on turning the country around economically, which is vastly more difficult that a corporate turnaround.

      1. Lex

        I’m not saying he has no domestic economic successes. He’s had a lot. And per capita income and GDP have improved remarkably. But it’s not necessarily even. I’m very familiar with the economic state of Russia when he took over because i saw it first hand. The changes are impressive. And his setting of the board by doing things like getting out from under IMF/WB debt is incredibly important.

        The flip side is how much foreign firms were responsible for industrial employment and economic activity, and/or reliance on export of raw materials rather than adding value to them. Nobody was going to do that overnight and choices always have to be made. Putin’s choices were important and set up the board to be able to make the next step. The one Russia is taking now.

        Perhaps I should have worded it better because I consider it a “failing” only in relation to his other accomplishments as opposed to it being a failure per se. If it was a failure Russia wouldn’t have been able to withstand the 2014 or current sanction regime.

        1. fjallstrom

          My impression is that he made sure to enforce the laws already on the books. Oligarchs could stay rich if they paid taxes and didn’t challenge the government. He also made sure government workers got paid on time. This meant cops didn’t have to rob people to get money, and so on.

          I was in Russia when cops robbing people was a daily occurrence. The mob dominated tourism board was angry at the cops for robbing the tourists who were supposed to spend their money at the mob controlled enterprises. The consulate recommended strongly not to carry your passport around, but make a copy. That way you can identify yourself but the cops can’t hold your actual passport for ransom. Surreal time and place.

          But if we see that as economic law enforcement policy, his governments general economic policies has mostly been to continue the neoliberal policies of the 90ies. And his approval ratings has often gone down because of pension reforms and such. (They go up when there’s a conflict with the west.)

          It will be interesting to see if this changes.

    2. Polar Socialist

      As much as we like to think so, Putin is not omnipotent. In domestic politics he has had to navigate between several groups and their agendas. The most prominent ones have been the new money (a.k.a. oligarchs), old industry (the powerful remains of the Soviet economy that did not die in the 90’s) and security services with often conflicting demands.

      Add to that his need to be a populist of some sort – at least saying (if not doing) the things majority of the electorate wants to hear. In that arena he has been constantly challenged by the Communists and Liberal Democrats who both publicly despise any neoliberal ideas and have demanded more of planned economy for years. And of course the noisy but small pack of the true liberals, who wanted to turn Russia into some neoliberal paradise and more western than The West.

  3. spud

    we should sanction everyone. then we can get rid of the economic nonsense of free trade/free market economics. and go back to bartering currencies, just plain barter, raise your own food, sell what you can, buy what you have to, and get the financial parasites off the back of humanity and the environment.

    1. Tom Pfotzer

      Solid, Brother Spud! *

      I was hoping you were going to say “we should sanction ourselves! It’d bust the oligarchs, cut the trade deficit, throw out the foreign owners of our rent streams, annoy the neoliberals, and above all, free beer on Fridays!”

      If we can’t find a way to sanction ourselves, maybe Russia and China will remember that they owe their prosperity to our goodwill (sanctions), and they’ll sanction us instead.

      * (if it’s not “Brother”, may I substitute “Sister”?)

  4. The Rev Kev

    In reading Sonnenfeld’s assessment of the Russian economy, perhaps that is a major reason why this war has gone on for so long. That if they believed that, then it was only a matter of holding on for a little more, just adding a few more sanctions and then the whole Russian economy would collapse after which it would be game over for the Russian Federation. Just gotta hang on for that bit more and keep everyone in line…

  5. JonnyJames

    “Thus one would expect improved market conditions in Russia and deterioration in Europe – and this is what we presently observe.” That seems to put it modestly. This is great that Galbraith has documented what we have suspected and some predicted long ago.

    I recall Michael Hudson stating many months ago that the sanctions and Ukraine war situation was an attack against EU countries, aka “Europe”) and would heavily damage EU economies, especially Germany, while benefiting Russia. This despite the claims of many “western” so-called experts. De-dollarization would accelerate and the vassals in Europe would become even more dependent on their imperial overlords. His predictions have been proven true, as usual.

  6. Questa Nota

    Russian Sanctions, another outburst from Congress in their attempts to get headlines and donations. They don’t stop to think through their actions, or the consequences, as they don’t believe that their constituents will. Too bad that their reactive approach typically ends up making the country and world worse off.

    The saying Knee-jerk politician needs to be updated. Any recommendations?

    1. JonnyJames

      A fancy classical Greek word: “kakistocracy” or kakistocrat,

      Plain English: we have many monosyllabic words to describe these politricksters: crook is one, but I can think of many others that George Carlin would use if he were still alive. The English language makes German sound smooth by comparison…

  7. Alex Cox

    Ten years ago Putin and Medvedev appeared to be neoliberals of the Tony Blair variety. What a difference the McCain/Neuland coup has made!

    As spud observes, we should all be sanctioned! For that way lies autarky.

  8. Peter VE

    Hal Freeman, an American who moved to a small town in Russia with his Russian wife in 2016, blogs at Between Two Worlds. He reported that the only real result he saw of the sanctions was the lack of peanut butter in his local grocery in Luga, and it came back after a month or so. He does have trouble collecting his Social Security, though.

    1. Tom Pfotzer

      Thanks for the link to Between Two Worlds. Very interesting reading, no way I ever would have found that myself.

    2. Bob Beck

      Thank you for the pointer to Between Two Worlds. It sounds like a hard life in many ways.

  9. Rob

    The geniuses who think that sanctions will bring the Russian economy to its knees fail to appreciate the fact that Russia is richer in natural resources than any other country in the world. Many of these resources (e.g. food, fertilizer, energy, minerals, etc) are of vital importance to a great many nations, including those in the western alliance. The point being that Russia’s natural wealth will provide a backstop against any serious economic plunge that sanctions are intended to produce.

    1. digi_owl

      It is also, even after the turmoil of the Yeltsin period, an industrial nation. It does not need to ship those resources off somewhere to have them processed and sold back at a markup.

      That is the IMF induced trap so many nations of the global south has found themselves in. And those that tried to fight it has been faced with endless revolutions and uprisings.

  10. Willow

    Sonnenfeld et al. Why are we not surprised that a bunch of MBA academics got it so badly wrong?

  11. Sergey P

    Great article, thanks Yves. Though having to regularly immense in ideological battles with Russian liberals in all their smug trying to imitate their American peers, I have to be careful with my sources.

    Mr Galbraith ends with

    We conclude that when applied to a large, resource-rich, technically-proficient economy, after a period of shock and adjustments, sanctions are isomorphic to a strict policy of trade protection, industrial policy, and capital controls. Such policies have been applied with success in other countries.

    But does not actually present any links or examples of success in countries adopting trade protection, industrial policy and capital controls. I tried finding them myself, but my knowledge of economic history is subpar, and I came up empty.

    Perhaps my favourite NC commentariat could prop me up on that front?

Comments are closed.