Finance, Trade, Great-ish Powers, and the Long Game: The Limits of Financial Pressure

By Sam Obenhaus
NATO-Ukraine Commission session in Brussels |
U.S. Department of State on Flickr 


Money flows quickly.  It has no morals and tends to have a very short memory.  In the case of great powers, it’s tentacles also bind economies together in ways that are hard to define and even harder to untangle.

This last trait has, of course, been a tremendous benefit of expanding trade and interdependence since the latter half of the 20th century.  Global trade, some like to say, is now “too big to fail.”  The interconnectedness it created pacified Europe, the most violent continent for the majority of recent history, and this is not about to change.  World War III, or even another Cold War, is not around the corner.

But has the deterrence of large-scale conflict come at the expense of reducing the expected costs associated with moderate acts of aggression?  This is the hypothesis Russian President Vladimir Put is testing in Crimea and maybe soon in Eastern Ukraine.

Sanctions, criminal probes of Putin confidants, and suspension of Russia from the G8 appear to be the limits of the international response.  Russia, simply put, is too engrained in the global economy to penalize more heavily.

Sanctions have a poor track record and only seem to work when there is a global consensus aligned against a pariah state that is effectively cut off from the global economy.   No one is suggesting such action against Russia, and Putin full well-knows that such action is impossible.  As the BBC noted, “After the European Union's display of unity of the lowest common denominator over sanctions, none of this is very encouraging for those who believe this is a key moment for the US and the West.”

Russia, unlike Iran or the few other states against which sanctions have been moderately successful, cannot be sanctioned without exposing the rest of the world to collateral damage.  Russian natural gas heats most of Europe, and Russia is the eighth largest investor economy in the world.  The U.K., for example, is the fifth largest beneficiary of Russian investment abroad.  The economic costs to imposing the type of sanctions that have proven effective, near complete isolation from the world economy, will not be imposed against Russia.

To the limited extent that sanctions are being used against key individuals and institutions, their impact is unlikely to be lasting.  There are some signs that sanctions are “rattling investors” and might even cause Russia to enter into a recession.

The first obvious question is whether such a story line is true and here is some evidence to suggest it is not, or that it is overblown.  Moscow’s largest stock exchange is up 40 percent since it bottomed out in the immediate run up to Crimea’s election to leave Ukraine.  In aggregate, foreign money is flowing out of Russia as a result of the crisis – some investors are undoubtedly scared that tensions will damages their investments.  But as the Financial Times reports,  “Interest from bargain hunters and contrarians has meant Russian equity funds have experienced positive inflows on some days since the crisis in Ukraine erupted.”

This speaks to a broader problem of using financial levers against great powers (or once-great powers with still considerable assets).  Capital, by its nature, is apolitical.  It seeks profits above all else. And even in the Obama administration, which has been pushing Europe to adopt more stringent sanctions, there is little appetite for restricting the free flow of private capital to Russia.

This gives Vladimir Putin every reason to believe that the short-term costs of Russia’s moderate acts of aggression are likely to be limited while the long-term costs will be close to non-existent.  Europe will not stop buying Russian natural gas, and investment in Russia’s massively underperforming economy will continue to lure investors seeking emerging market rates of return.  Russia will rebound, and when it does, it will have Crimea.

If Putin’s reading of situation proves correct, it will require a great deal of introspection in the West.  Broadly defining the West’s sphere of influence to include places that our leaders are unwilling to protect – even with strictly financial tools like effective sanctions – erodes Western power.

Responding requires recalibrating the Western sphere of influence or turning the West’s relationship of mutual dependence on Russia into one of unilateral dependence.  The former path is easy and, in the near-term, costless.   The later path requires investment in domestic energy production, and many hard and expensive choices.  The West should choose the latter.