The Unintended Consequences of Economic Sanctions

A review of Agathe Demarais, “Backfire: How Sanctions Reshape the World Against U.S. Interests” (Columbia University Press, 2022), and Daniel McDowell, “Bucking the Buck: US Financial Sanctions and the International Backlash against the Dollar” (Oxford University Press, 2023)

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Economic sanctions are being used more and more often but also face more questions of effectiveness, especially as they are used on larger and larger targets. The recent anniversary of the 2022 Russian invasion of Ukraine prompted considerable analysis of the effectiveness of economic sanctions. In the Russia case, sanctions are clearly having an economic impact, reducing Russia’s economic and policy choices, resulting in a smaller but more centralized economy that is increasingly reliant on a smaller number of trading partners. However, there are no signs that the war is coming to an end. The Russian sanctions highlight two linked trends—the economic impacts of sanctions may build over time, impairing future investment and growth, while at the same time workarounds develop, creating resiliency. To maintain similar levels of pressure, new sanctions are required, often creating a whack-a-mole situation.

While sanctions clearly bring economic stress and political impacts, including potential consolidations of power within the target governments, there is less evidence about their ability to bring behavioral change, as even policymakers like Janet Yellen seem recently to have pondered. Policymakers in the U.S. have begun to shift away from a prior assessment that sanctions are meant to prompt policy change, and more applications seem designed to degrade and limit the access of malign actors to the global economy. Russia is a case in point.

Two recent books add to the literature on how sanctions are reshaping the global economy and the intended and unintended consequences of that reshaping. They also call into question whether broader use might undermine U.S. interests and the role of the U.S. dollar in the global economy. These books are important additions to the literature, both for their case studies and data collection and for their clear explanations of complex financial plumbing, export controls, and supply chain integration.

“Backfire: How Sanctions Reshape the World Against U.S. Interests” (2022) by Agathe Demarais, a former French diplomat, takes an expansive look at economic sanctions, including financial restrictions on transactions, export controls, and investment bans used for foreign policy aims. She aims to map the “ripple effects” of these policies, including their impact on health and economic resilience, to assess their effectiveness. Using well-researched case studies including many from Iran, she argues that sanctions, particularly unilateral ones with growing scope, risk undermining U.S. interests. Choices by target countries to resist and adjust rather than make policy changes may have externalities on domestic and global politics and lead to sanctions remaining in place even after they are no longer fit for purpose.

Demarais argues that “effective sanctions are in place for the short term, have a narrow goal, target a democracy that has significant ties with the United States, and are backed by American allies.” Very few U.S. sanctions programs meet these criteria. Indeed many sanctions remain in place for many years and are removed only belatedly. She points to negative ripple effects, including choking off humanitarian trade, which is typically supposed to be protected from sanctions, something that is harder to do in practice. These trends and other sources of resilience to sanctions risk reinforcing rather than undermining the powerful entities that face sanctions, which may reduce the sanctions’ legitimacy and effectiveness. In a similar vein, these tools may be less powerful in authoritarian states, which may leverage domestic support against the sanctions.

In “Bucking the Buck: US Financial Sanctions and the International Backlash against the Dollar,” Daniel McDowell focuses more narrowly on financial sanctions—restrictions on financial transactions—and their impact on the global role of the U.S. dollar. The asymmetric power of U.S./Group of Seven (G-7) economic sanctions stems from the dominant role of the U.S. dollar, the depth of the U.S. Treasury market, and links within the North Atlantic and G-7 financial systems. Cutting off individuals, businesses, or states from access to the dollar limits their ability to conduct trade, fund themselves, and conduct independent policy. McDowell finds evidence that sanctions increase the incentive to reduce exposure to the dollar by sanctioned countries and even some countries that are not yet targets.

Keeping up with the highly eventful past year of economic statecraft, these two books help to explain and signpost the economic conflict with Russia and provide concerning lessons for potential attempts to build coalitions to contain China. Demarais’s analysis is most forward looking in her deep dive into export controls, which she calls the “sanctions of the future[.]” In truth, export controls on dual use technologies are already powerful tools being used both to limit China’s move up the value chain in strategic sectors and in efforts to restrict Russia’s military restocking. However, outside of the U.S., enforcement capacities on export controls leave a lot to be desired. Demarais foreshadows some of the enforcement challenges that have arisen in U.S. efforts in 2022 to build a coalition to restrict China’s access to the cutting edge of semiconductors. 

Demarais’s analysis bears the scars of her being a French diplomat in a time of greater U.S. unilateral use of economic coercion, wounds that remain for many policymakers despite the current G-7/G-10 alignment over Russia (and to some extent Iran, Myanmar, and some other sanctioned jurisdictions). “Backfire” is particularly strong on the concerns that European political leaders had over the United States’ unilateral use of sanctions. These policies, plus U.S. tariffs on European and allied goods, fueled the “strategic autonomy” agenda aimed at ensuring the EU could conduct its own foreign policy. The recently approved EU anti-coercion instrument may now be more focused on ensuring EU interests are not trampled by authoritarian states, but strategic autonomy pervades in debates over how far to reduce reliance on China in both critical and noncritical supply chains.

McDowell’s data gives a powerful snapshot of the state of play in global reserves and currency markets and sanctions as Russia’s renewed invasion of Ukraine kicked off, and he also informs more recent developments. One of his strongest contributions to the literature is marrying close assessment of the cases, including the public statements of thought leaders in target countries (China, Turkey), with data collection and some straightforward and logical econometric results. McDowell tracks the use of the U.S. dollar for savings (reserves), transactions invoicing and payments, and the historic roles of a reserve currency. Unsurprisingly, there have been more moves away from the dollar for trade transactions than savings. He finds, even in 2021, that of major economies, Russia had gone the farthest to de-dollarize. Russia was much more effective at avoiding the dollar in its exports but much less able to diversify the currencies of its imports, something that arguably added to the import shock it faced in the first waves of 2022 sanctions. More problematic for Russia, much of its initial de-dollarization was into the euro, and the countries that use the euro matched U.S. sanctions, limiting its use as an alternative currency.

McDowell’s data and models help make the case that sanctions are reducing the use of the dollar in some countries (notably Russia and, to a lesser extent, Turkey). This trend may increase as more countries either face sanctions or seek to trade with sanctioned countries like Russia. The breadth and depth of sanctions on major economies like Russia and China may only increase this incentive, especially as approved carve-outs for legal trade are very difficult to implement. Countries such as India and the United Arab Emirates (UAE) are key places to watch as they try to maintain trade with Russia and security relationships with the U.S. and regional players. Domestic economic and security policies including capital controls (India) and dollar pegs (UAE, Gulf Cooperation Council states) may limit these efforts.

On a topic so often politicized and at risk of being overstated or understated, McDowell stakes out a middle ground, showing evidence that sanctions increase the political risk central banks and firms perceive when making their investment and transaction decisions. He also makes a point of highlighting potential non-sanctions-related economic drivers of these choices, including returns on investment, which arguably reinforced the impact of sanctions. Often sanctions alone may not be the only reason firms are wary of transactions. European firms, for example, were wary of returning to Iran due not only to the risk of sanctions re-imposition but also to related-party bank lending, terrorism exposures, corruption issues, and dominance of the Islamic Revolutionary Guard Corps. McDowell may underestimate the impact of Venezuela’s effective default and arrears on the country’s shift to physical gold and away from the dollar, which predated sanctions.

Demarais highlights the increasing use of crypto currencies, and central bank digital currencies, which could over time create new payment channels that skirt current payment systems. She highlights key shifts in the global economy, including renminbi swap lines and the use of Chinese bank messaging systems, which could reduce the role of the SWIFT messaging system from which many Russian, Iranian, and Syrian banks are disconnected. Developing such systems may allow them to be deployed in a crisis, when the higher costs of switching are the only option. This could lead to an important tipping point, replacing the dollar in some jurisdictions but increasing the use of alternative currencies. This in turn might reduce the power of future sanctions and bring other costs to the imposing countries.

In his book, McDowell is somewhat more circumspect on the utilization of these Chinese pathways, as the evidence is limited for their current use, largely because of choices China has made. China remains ambivalent about the loss of economic and financial control implied by making the renminbi a much more international currency. Its payment system (CIPS) still uses SWIFT for most messaging, which limits its utility as an alternative. In particular, China has been wary of letting other countries use their currency in bilateral trade without a Chinese nexus. For example, in 2022 and 2023, China has been quite willing to allow Russia to use the renminbi in bilateral trade, to issue corporate debt, and increase savings, but it has been less willing to allow its currency to be used by Russia in its trade with third countries. That may be a key tipping point. As the U.S. and allies dive deeper into the use of sanctions and other restrictions and China seeks to de-Americanize certain supply chains, these costs may seem worthwhile or a needed survival choice for China’s long game.

Do these ripple effects and unintended consequences mean sanctions should be used less? Perhaps. These books highlight the need for more study, clarity of goals, and assessment of outcomes. Demarais highlights the importance of goals and assessing trade-offs from sanctions. She suggests that the time of U.S. unilateral sanctions has peaked and that maintaining the power of sanctions requires coordination among allies, clear goals, as well as mitigating the impact of alternate trading partners that might replace the U.S. and allies. Since 2022, the risks of splintering among developed economies seem to have receded, at least temporarily and with respect to Russia. A coalition of developed economies has clung together to reduce economic links with Russia and is somewhat more aligned with other countries, including even some of the risks associated with China.

However, the G-7 Plus has been much less successful at mitigating new trade links or in convincing other emerging economies to join these economic pressure campaigns. In part, this reflects the sheer size and global reliance on Russia’s energy and commodity exports, which has prompted creative solutions like the oil price cap, which aims to redirect trade and increase costs for Russia. The sanctioning coalition is in a tougher rhetorical position of urging countries to buy some Russian goods at a discount but not to sell it other items—a tougher, if needed, stance. At the same time, the G-7 initially focused much more on energy security concerns, especially those in Europe, and underestimated some of the food security worries relevant to many developed economies. These seeming inconsistencies coincide with a growing number of countries in Asia and the Middle East seeking to maintain multiple alignments to better meet their national interests. These divergences would likely only become more acute with any effort to significantly step up economic pressure on China.

McDowell asserts that dollar dominance is here to stay for the foreseeable future, not least because of the limitations of existing alternatives, especially the renminbi and euro. But his analysis and recent developments highlight the risks that if more and more large countries are subject to sanctions, pockets of alternative currencies are possible, which would reduce both the U.S. panopticon (monitoring) and chokepoint role as described in the weaponized interdependence work of Henry Farrell and Abraham Newman. These pockets could of course grow over time, adding costs and uncertainty, not just to sanctions targets but also to sanctions senders and the global economy.

The ripple effects or costs—whether they include new grievances, new players increasing their dominance of key infrastructure, or the difficulty coordinating solutions to global problems such as debt relief and climate change mitigation—may only grow. This means the U.S. and its allies have key choices to make. Regularly assessing the realistic goals and outcomes of sanctions and monitoring their impact is key to assessing whether the trade-offs are worth it and if new costs and trade-offs are materializing. These two books help add to the literature, help explain complicated financial plumbing and supply chains, and highlight some key data points to track and potential inflection points to watch.