Over one week into Ukraine’s surprise incursion into Russia, it appears the gamble has, so far, paid off.
What is less of a cause for celebration is the state of our sanctions regime. Britain can rightly be proud of the military and economic support we’ve given to Ukraine, and the aims of the economic punishments we’ve slapped on Russia are noble ones. Unfortunately, they’ve been demonstrably ineffective.
The reason that we use economic sanctions is a simple one – it’s because we want states to stop doing something. This applies to other countries we’ve sanctioned, including Iran and North Korea, as well as Russia.
The best way of doing this isn’t to just signal that we disapprove of what they’re up to, it’s to make it much more difficult for them to keep doing it. This involves both stopping them from getting their hands on technologies and materials and damaging their economy so they can’t continue to finance their malign activities. Experts in the field call this ‘disrupting.’
In the case of Russia, our sanctions have not sufficiently ‘disrupted’ Putin’s war. Russia has clearly been able to mitigate the effect of export controls, mainly by trading via third countries such as China. One of the results of this is that they’ve been able to obtain Western components for battlefield munitions. According to Ukraine’s National Agency for Corruption Prevention (NACP), 95% of all parts found in Russian weapons on the battlefield originated in countries that are part of the sanctions coalition. By contrast, Chinese-origin components only made up 4% of the parts found.
As for Russia’s overall economic performance, the IMF has recently upgraded its projections for its economic growth this year to 3.2% – a much faster rate than all the world’s advanced economies. By contrast, the UK’s expected growth rate is 0.5%.
One of the principal reasons for this failure is that entities – which can mean either individuals or businesses – are still engaging in commercial activity in sanctioned states, and are not being dissuaded from doing so again when they are caught. The maximum civil monetary penalty that can be imposed if they are caught is £1 million or 50% of the breach, whichever is higher. For entities who are making serious money from trading with places like Russia, this is an acceptable cost of doing business.
As any economist worth their salt will tell you, if you want to get commercial actors to change their behaviour, you have to offer them a carrot as well as a stick. In this case, we should be using incentives to encourage sanctioned entities to divert their business to the UK by giving them the opportunity to profit here, in a way that benefits us at the expense of sanctioned states.
And that’s exactly what we at the Adam Smith Institute suggest in our new ‘compelled reinvestment’ scheme. Under this proposal, if an entity was found to have violated our sanctions regime, they would be given a choice to either face the normal penalty, or to reinvest its capital or any proceeds from an investment in a sanctioned country back into the UK, rather than having their assets frozen.
The UK Government could decide that the most productive use of the funds is to maintain or even expand a current investment in the UK. Or it could invest the money in whatever would most benefit the British public such as an important infrastructure project, or it could take the money as a loan with a small interest rate to finance public spending.
A caveat here – we obviously cannot allow anyone who is directly involved in, for example, the war or human rights abuses in Ukraine, to profit. Any profits from a successful investment project could be calibrated to the culpability of the sanctioned entity, with a zero-interest, no-profit category available for the very worst offenders. This would be considered on a case-by-case basis.
The goal of our sanctions policy should not be to isolate investors and businesses, it should be to economically isolate hostile states like Russia. Introducing compelled reinvestment sanctions to our sanctions framework will make it far more robust and able to engender the UK’s desired outcomes.
Click here to subscribe to our daily briefing – the best pieces from CapX and across the web.
CapX depends on the generosity of its readers. If you value what we do, please consider making a donation.
