Sanctions Could Harm Us and Bolster Russia on the World Stage | Opinion

It is hard not to feel sympathy for the people of Ukraine. The Russian invasion is violent and bloody. It imposes on a people's sovereign right to self-determination. But we cannot allow our sympathy for the suffering of the Ukrainian people to lead us into bad decisions that will have detrimental effects on our wealth and security. The current sanctions on Russia threaten to do just that.

In their modern form, sanctions were first used in earnest against Cuba in 1960. In response to the Cuban government nationalizing U.S.-owned oil refineries without compensation, the U.S. announced an embargo on any exports to Cuba that were not food or medicine. Were these sanctions successful? They were, if their goal was to cripple the Cuban economy. But if the goal was to bring about the overthrow of the Castro regime, they were clearly a failure.

The current Russian sanctions appear to be more closely modeled on the Iran banking sanctions from 2006, however. These sanctions succeeded in hobbling Iranian oil exports, the lifeblood of the Iranian economy. In 2006 Iran produced more than 3.8 million barrels of oil a day. By 2019 this had fallen to less than 2.3 million barrels—a decline of more than a third. Since the Russian economy is also reliant on energy exports, the Iran model seems at first glance to fit. But does it?

Short answer: no. Russia is not Iran. Its capacity for energy production is much higher, and much more important for the rest of the world. In 2014, Iran produced around 4 percent of the world's oil output. As of 2019, Russia produces just under 13 percent. Russian energy is a pillar of the European economy, which sources around 25 percent of its oil, and 40 percent of its natural gas, from Russia.

The current sanctions do not aim at cutting off Russia's supply of energy to Europe. Right now, cooler heads are prevailing. What the current sanctions are doing, however, is making markets nervous. This nervousness is driving up oil prices, which were already under pressure from the war itself. The day before Russia's invasion of Ukraine the Brent oil price stood at around $94. Last week it reached $129, with rumors swirling that it could climb to anywhere between $150 and $180 a barrel.

Here is what the politicians aren't telling you: these higher prices hurt the West and benefit Russia. Russia is an energy producer; we are energy consumers. When prices rise, we pay more for oil while Russia gets to cash in on higher prices. We are already seeing these prices benefit the Russian trade balance. In January-February 2022 the Russian trade balances stood at $46.2 billion, a full 152 percent increase from the $18.3 billion trade balance a year earlier.

Recall that in January and February, Russia only saw four days' worth of these sky-high oil prices, so its trade balance is only going to improve further. I ran a model estimating the impact of $150-180 prices on Russian trade. I found that the current account—that is, the total foreign payments Russia receives—could rise to between 20 percent and 25 percent of GDP. This would mean that every year, Russia would be accumulating debts on its trade partner equal to 20-25 percent of Russia's entire GDP. This would not only make Russia much richer, but it would also give the country more diplomatic power over the countries falling into debt—with Europe being top of that pile.

Is the answer then to convince the Europeans to cut their reliance on Russian energy immediately? That will not work either. I estimated another model where I assumed that Europe managed to completely block Russian energy imports and Russia failed completely to sell these anywhere else. I found that although the number of barrels Russia exported would fall, oil prices would rise so high that they would balance out the decline in barrels sold. Russia would end up with the same trade account it has today but would have to sell less oil to get it. Big win.

It is also worth noting what would happen to Europe in this scenario. The continent would probably have to resort to energy rationing. Factories and workplaces would close due to blackouts. Economic output would crash. The continent would face extremely high inflation, possibly even hyperinflation.

It cannot be stated emphatically enough: energy sanctions, even in their current mild form, are massively benefiting Russia and harming us. It is madness that we are pursuing these policies.

What about the other sanctions? Banking sanctions are clearly working. You cannot use Visa or Mastercard in Russia or to purchase from Russian stores online. But there is a carve-out for energy—obviously, as Europe needs it. So, these sanctions mainly affect small business owners who sold goods to the West. These are exactly the sort of Russian citizens who would have a more favorable view on average of the West. Meanwhile, the oligarchs in the energy sector with ties to the Kremlin are still raking in profits.

At a more macro-level, these sanctions encourage other countries to create alternatives to the dollar-denominated global banking system. Russian banks have already announced that they are going to use China's UnionPay. This just bolsters the use of the Chinese renminbi in global trade and diminishes the importance of the dollar-based SWIFT system. India, a U.S. ally and key global partner for the Iranian boycott, announced it is exploring a rupee-rouble system for trading Russian oil that will be backed by the Chinese. We are cutting off our nose to spite our face, as the saying goes.

Meanwhile, boycotts of Western software companies are pushing Russia to legalize piracy within the Federation. A major state actor is tearing up international copyright law and will distribute pirated versions of Western software for free or at lower cost going forward. We are engaged in a fantasy if we think this will not have dire long-term implications for our leading software companies.

We would be wise to wind back these sanctions as soon as possible. We probably cannot do so right now—although we should commit not to adding any more. But as negotiations commence between the Russians and the Ukrainians, we should have a plan to remove most of the sanctions. The sad reality is, however, that some of the effects are probably irreversible.

Philip Pilkington is a macroeconomist with nearly a decade of experience working in investment markets, he is the author of the book The Reformation in Economics: A Deconstruction and Reconstruction of Economic Theory.

The views expressed in this article are the writer's own.