Plugging the Leaks

Now, two years on, it is clear that the strategy did not work. Russia’s economy, despite a raft of additional sanction packages from the US and the EU, remains buoyant. A large part of the reason is that many developing countries lack incentives to comply, as sanctions severely restrict trade, a key element for their economic development. Furthermore, these countries harbour objectives that do not align with either side of the West-Russia rivalry. For instance, while they show little interest in challenging US leadership, they carefully weigh the extent to which they will comply with or evade sanctions against Russia. Their non-participation substantially undermines the effectiveness of Western sanctions.

In their latest CESifo Working Paper, Haishi Li, Zhi Li, Ziho Park, Yulin Wang, and Jing Wu used detailed transaction-level export and import data from three major developing economies (India, Mexico, and Vietnam, which have all officially declined to participate in Western sanctions against Russia) as well as firm-level balance-sheet information to examine how firms in neutral developing countries have adjusted their supply chains in response to this geopolitical and economic fragmentation, and what channels they are using to comply with or bypass sanctions.

After the start of the Russo-Ukrainian War, exports from Western sanctioning countries to Russia and Belarus declined for both sanctioned and non-sanctioned products, with a more pronounced drop in sanctioned products. In contrast, exports from non-sanctioning countries largely rebounded after the war, especially for sanctioned products—an outcome contrary to what Western sanctioning countries intended.

There are two key mechanisms through which Western sanctions on Russia and Belarus affect supply chains in neutral developing countries: extraterritorial export product sanctions that multinational enterprises (MNEs) from sanctioning countries must comply with, and financial sanctions. The export product controls require that regardless of the firm’s location, if the sanctioned product uses technologies from the sanctioning countries or is manufactured in facilities using sanctioning countries’ technologies, it cannot be exported to Russia and Belarus.

MNEs headquartered in sanctioning countries reduced their exports of sanctioned products to Russia and Belarus by 54% more than those of non-sanctioned products. This way, MNEs from sanctioning countries propagated their headquarters export product sanctions globally and extended their headquarters’ geopolitical influence to neutral countries.

In contrast, MNEs and domestic firms from non-sanctioning countries did not display this behaviour. In relative terms, sanctioning MNEs’ exports of sanctioned products to Russia and Belarus decreased by 99% more than those of neutral countries’ domestic firms, which instead showed a 48% increase in exports of sanctioned products to Russia and Belarus relative to non-sanctioned products.

Exports of sanctioned products by sanctioning MNEs to many non-Russian and non-Belarusian destinations increased after the war, including to Russia-friendly countries such as those in the Commonwealth of Independent States and those using Russia’s payment system. In contrast, neutral-country domestic firms and non-sanctioning MNEs exhibited less growth in exports to Russia-friendly countries, since they could export directly to Russia and Belarus.

When financial sanctions are considered, however, there may be a way to coax neutral developing countries to adhere to Western sanctions. So far, financial sanctions have not significantly impacted neutral developing-country firms’ exports, enabling them to distance themselves from Western sanctions, but MNEs operating in those countries are a different matter altogether. Since they are more sensitive to financial sanctions, they could see the incentive more sharply to comply with export sanctions if they face financial penalties. And given the significant role that such MNEs play in the neutral host countries’ supply chains, they might move these countries to become more compliant.

Whether that would be enough to end the more than two years of butchery and destruction being meted out on Ukraine remains to be seen.