There is a strange irony in that sanctions are the most overused tool in the policy kit despite being ineffective when unaccompanied by other measures. Russia, Iran, Venezuela, Cuba and North Korea are all under Western sanctions. The goal: to tie the regime’s hands so that they will be forced to change course. Or so the theory goes. You can judge for yourself how much they have changed their behaviour on the world stage. Nevertheless, in recent years, sanctions have become the go-to move for Western governments. If we want to rein in a regime, we hit their companies, banks and power-brokers.
But it’s easy to see the appeal. Western States are reluctant to commit to protracted and costly military conflicts abroad. Sanctions are a middle-ground as they are more coercive than straight-up diplomacy, but far less risky than military action. As Bill Reinsch, who was U.S. Under-Secretary of Commerce under President Bill Clinton, put it: “It is the only thing between diplomacy and war”.
The sanction regime has changed over time. Gone are the days of sweeping embargoes that harmed entire populations. The crude measures of the 1990s – like those imposed on Iraq and the former Yugoslavia – hurt civilians more than elites. Today, we have “smart sanctions” instead. They target powerful individuals, companies and sectors, and are meant to spare the general population.
Russia and Iran have become the case study for the efficacy of sanctions. Since Russia’s full-scale invasion of Ukraine in February 2022, it has faced some of the toughest sanctions in modern history. Western government have frozen the Russian central bank’s reserves abroad, cut major Russian banks off from the SWIFT payment system and at one point even capped oil prices.
The objective was to cripple Russia’s economy and therefore reduce its ability to wage war. Russian propaganda sought to undercut this citing the fact that last year, Russia’s GDP grew by more than 4 per cent, outperforming many Western economies.
Nonetheless, Russia is hardly thriving. Foreign direct investment into the country has plummeted, and exports are down. The recent growth is driven by massive wartime spending and an increase in the wages of public sector employees, acting as artificial stimulus.
Similarly, the Iranian regime is facing enormous stresses ranging from high levels of unemployment and inflation, increased social unrest, and the regime’s poor investment in infrastructure that has contributed to a severe water shortage in Tehran.
The Kremlin has sought to circumvent sanctions by turning Russia into a fortress economy as well as pivoting away from the West, deepening ties with countries like China and India as well as Middle Eastern powers like Saudi Arabia. Russia has also found ways to circumvent sanctions by rerouting trade through third countries. My report, ‘Regime Collapse in Iran: A Necessity for Regional Stability?’ identifies that Iran similarly pursues a “Look East” policy. This is similar to Russia’s aspiration to circumvent US led sanctions, and gain access to alternative financing systems, technology transfers and energy markets
Still, despite this, we must acknowledge that sanctions have not yet forced Vladimir Putin to the negotiating table. Nor have they meaningfully reduced his ability to fund the war in Ukraine. Similarly, Iran has not ceased exporting terrorism or abandoned its attempt to reconstitute its nuclear program. These are aimed at confronting the U.S. which it calls the ‘great Satan’ and eliminating Israel, the ‘little Satan’. These revolutionary goals are deemed by the Iranian regime as critical for the survival of the Iranian regime.
Regardless of the risk of authoritarian regimes pivoting eastwards, even within Western States, sanctions often are not enforced as policymakers fail to close loopholes. Investors can legally trade the bonds of sanctioned companies and countries – as long as they do not buy directly from them. Hedge funds purchase the bonds at a discount and bet that sanctions will eventually be eased, or that the country’s economy will recover. If either happens, they can sell the bonds for a profit. Again, all perfectly lawful.
Take, for instance, bonds issued by Petroleos de Venezuela SA (PDVSA), the Venezuelan state-owned oil company. PDVSA has been under U.S. sanctions since 2019. The U.S. Treasury has called it “a vehicle for corruption” due to its close ties with the government of Nicolás Maduro.
For years, trading most PDVSA bonds on the secondary market – where investors buy and sell debt – was banned. But in 2023, ahead of the country’s presidential election, the U.S. lifted that restriction.
As such, it become legal again to trade PDVSA bonds. Investor interest piqued. Several funds, including Gramercy Funds Management LLC, perhaps known best in the UK for funding class action law firm Pogust Goodhead and William Blair & Company, started scooping up PDVSA notes for as little as 11 cents on the dollar, according to Bloomberg.
The thinking was simple: the presidential election raised the odds of a political transition – and with it, the chance of a long-awaited debt restructuring. “They want access to capital markets,” Robert Koenigsberger, managing partner and chief investment officer at Gramercy, told Bloomberg. “If you have a credit culture, you don’t think about how you screw the bondholders.”
This kind of trading is legal, but it exposes a flaw in the sanctions regime. Sanctions are supposed to isolate bad actors and exert pressure on their economies. But when sanctioned debt becomes a financial asset, it works against that goal. A tool of foreign policy risks turning into a vehicle for speculation. The same dynamic has also occurred with Belarusian debt and Russian corporate debt, among others.
The U.S. and its allies should therefore tighten the rules. There should be no secondary market to trade the bonds of companies in sanctioned countries, even if those companies are not themselves blacklisted.
But that’s not enough. It must also become harder to get around sanctions by exporting goods through third countries. Western firms should check their supply chains more carefully so that they are not using anything from a sanctioned country.
To enforce this, Western governments should set up independent sanctions regulators. The model is the U.S. Securities and Exchange Commission, which was created by President Franklin D. Roosevelt to police Wall Street after the Great Crash of 1929. A sanctions regulator would play a similar role: auditing supply chains, monitoring financial trades and investigating companies suspected of wittingly or unwittingly helping sanctioned regimes.
It’s the only way to ensure that sanctions have the impact our leaders claim to want. Last month, Sir Keir Starmer announced new sanctions on Russia. “These sanctions strike right at the heart of Putin’s war machine,” he said defiantly. “The threat posed by Russia cannot be underestimated, so I’m determined to take every step necessary to protect our national security and keep our country safe and secure.” This was soon followed by the E3 consisting of Britain, France and Germany imposing snapback sanctions on Iran for failing to comply with commitments made in a 2015 deal over its nuclear program.
While sanctions alone as a tool as not an adequate policy, they must be effectively enforced. The alternative is for authoritarian regimes such as Iran and Russia exploiting loopholes while reorienting their economies eastwards. The only beneficiary of this is China. Now is the time to take further steps.
Our political leaders are addicted to them. Whenever there is a crisis, they reach for them. Whenever there is a threat, they reach for them. Whenever they need to look tough, they reach for them. Every time, they offer a quick hit and make our leaders feel powerful. But the effect wears off fast.
We are talking about sanctions, of course. For all the hype, they rarely deliver the results we hope for. It’s time to overhaul the sanctions regime.
For all the hype sanctions rarely deliver the results, we must learn from our past mistakes
