How do imposed sanctions impact firms?

JCMS | 19 April 2021

By Michal Onderco & Reinout A van der Veer

Last week, the European Union agreed to impose new sanctions on Russia in response to the attempt to poison the opposition activist Alexei Navalny and his jailing upon return to Russia. Immediately afterwards, Russia threatened to respond in kind.

This development is not new. In recent years, the European Union, just like many other actors in global politics, increased the use of sanctions as a foreign policy tool.  This is even likely to increase in the future. The current European Commission, calling itself “the geopolitical commission”, announced plans to prepare “a  reinforced  sanctions  mechanism  […]  to ensure that Europe is more resilient to extraterritorial sanctions by third countries and that sanctions imposed by the EU are properly enforced.”

Increasingly, Europeans are becoming sensitive to the domestic costs of imposed sanctions. Nowhere was this argument clearer than in case of European sanctions against Russia, particularly after Russia instituted its own counter-sanctions designed to hurt European countries back. Now Russia threatens to do the same.

In our recent article in JCMS, we look at the costs that these sanctions bring to the firms in EU countries. We look at the Russian counter-sanctions for two reasons: they are widely understood to have been imposed in reaction to EU sanctions, and they are often conflated in popular discourse. Because they are Russia’s reaction to EU’s sanctions, their impact on European businesses tells us a lot about EU’s ability to weather the domestic costs of economic sanctions.

We utilize a unique data source: a database covering all Dutch exports, supplied by Statistics Netherlands. We use a quasi-experimental research design, which allows us to compare firms that were hit by the sanctions (our ‘treatment’) to firms that are comparable on all aspects except that they did not face the Russian sanctions. We look at the Netherlands, because it is a relatively large, open, and export-driven European economy which primarily exports food to Russia, and the Russian ban was aimed at these products especially.

We were mainly interested in two questions: whether the companies hit by the sanctions have a higher chance of (1) losing revenue and (2) ceasing exports altogether to Russia or elsewhere (which we refer to as firm failure), and (3) whether they were more likely to start exporting to countries near Russia, perhaps in an attempt to bypass the sanctions.

Our results indicate that firms that were hit by Russian sanctions were between 86% and 96% more likely to cease operations by 2015 and 2016 (respectively) compared to the firms that were not hit by the sanctions. However, we also find that the effect on revenue is negligible – in other words, if the firms survive, their exports do tend to recover fairly quickly and they do not suffer from the sanctions imposition afterwards.

We also see that the bigger the share of the firm’s revenue going to Russia, the more likely the firm was to stop exporting. At the same time, the big exporters that export only a small share of their products to Russia faced little impact. This is not entirely surprising – because these firms are much bigger, they also are much more likely to have the expertise and resources to implement sanctions. The higher risk of failing was especially visible for smaller firms in the chemicals and minerals industry, which exported between a quarter and half of their goods to Russia. Two-thirds of these firms failed in 2015 and 2016. Our research corroborates the earlier findings that highlighted that some sectors of Dutch economy were much more vulnerable than others. Agriculture is often listed as such sector, observation also recently confirmed by the Dutch agricultural diplomat in Moscow.

We also find that Dutch exporters that were hit with sanctions were more likely to divert their exports (i.e. whether they began exporting without precedent) to Belarus, Moldova, the Caucasus, Mongolia and China, but also Israel. We do not find evidence of such export diversion to other EU countries, where Dutch firms might already have an easy access. Neither did Dutch companies divert exports to Central Asia or Turkey, which offer less attractive options for diversion. Similarly, Ukraine’s conflict with Ukraine may explain why the Dutch businesses did not divert there.

Our results suggest that policy-makers who wish to help businesses to overcome the economic hardship caused by the sanctions (or retaliatory sanctions) should focus primarily on helping companies to survive in the short term, and focus on smaller companies that are more exposed to the sanctions. After this initial period, companies are able to bypass the sanctions by diverting their exports to other countries. Importantly, by now, the Russian counter-sanctions no longer hurt European businesses. Economic arguments based on their impact on firms should therefore not aminate the policy thinking about whether to keep sanctions on Russia or not.

This blog post draws on the JCMS article “No More Gouda in Moscow? Distributive Effects of the Imposition of Sanctions”

Michal Onderco is Associate Professor at Erasmus University Rotterdam. His research focuses on politics of international security, with particular attention to the role of domestic actors in foreign and security policy.

Reinout van der Veer is an Assistant Professor at the Radboud University Nijmegen. His research interests include EU and EMU politics, the role of experts and expertise in liberal democracy, and the politicization and legitimacy of international organizations.