Tag: Sactions

Econ 101:  Oil Price Cap

Among U.S. (and E.U. and some other primarily Northern countries) objectives in reacting to Russia’s invasion of Ukraine, is to diminish its capacity to continue this war, in part by reducing its export (largely oil and gas) income with minimum damage to the U.S. and other embargo supporters and to pressure it to the bargaining table sooner rather than later (we are trying to do that aren’t we??). As you can see from the previous sentence, this is not a particularly simple issue.

One measure being promoted by U.S. Treasury Secretary Janet Yellen is to cap the price at which we are willing to buy Russian oil.  If we just stop buying Russian oil all together (effectively a price of zero), global oil supply would presumably fall, and oil prices would rise. We know, of course that Russia will redirect its sales to countries not participating in the embargo, such as China and India, to the extent it can and the oil these countries would have purchased from Saudi Arabia and other suppliers would then be available to us and global oil supply would not fall as much as we might have expected nor would prices increase as much as otherwise. Much could be written about this (the limited potential of embargoes if not everyone participates), but I won’t.

The idea of Secretary Yellen’s cap is that rather than buying no Russia oil we (and all embargo participants) would continue to buy it but at an agreed price that is below normal market prices in normal time (the price cap). Thus, hopefully, Russia would still sell its oil to the West but would earn less foreign exchange from it and the West would have more oil than with a total blockage and thus avoid sharp market price increases.

“There are several outstanding issues to settle on the price-cap idea. Those include figuring out exactly how to enforce it, convincing other nations to subscribe to it and deciding the sales price at which Western countries would permit the purchase of Russian oil. Looming over the proposal is also the presumption that Russia would continue to sell oil at a price mandated by the U.S. and its allies.”  “WSJ: Janet Yellen begins Asia trip to win support for cap on Russian oil price”

“Some economists and oil industry experts are skeptical that the plan will work, either as a way to reduce revenues for the Kremlin or to push down prices at the pump. They warn the plan could mostly enrich oil refiners and could be ripe for evasion by Russia and its allies. Moscow could refuse to sell at the capped price…. 

“Mr. Biden… moved swiftly to ban imports of Russian oil to the United States and coordinate similar bans among allies. In some ways, the price-cap proposal is an acknowledgment that those penalties have not worked as intended: Russia has continued to sell oil at elevated prices — even accounting for the discounts it is giving to buyers like India and China, which did not join in the oil sanctions — while Western drivers pay a premium….

“The cap plan seeks to keep the Russian oil moving to market, but only if it is steeply discounted. Russia could still ship its oil with Western backing if that oil is sold for no more than a price set by the cap.”  “NYT Biden gas price cap Russia”

John Bolton, whose view I don’t generally share, said about Yellen’s oil price cap: “The proposal, academic and untried, faces multiple practical obstacles and uncertainties. Widespread sanctions violations by Russian maritime cargoes already exist, with no reason to think the oil-price cap is more enforceable.” “WP: Biden oil price cap-Russia Sanctions”

Such efforts to “hurt” Russia cannot avoid also hurting us. What other approaches might the Biden administration consider?

“The White House… has held off for months on backing a gas tax holiday, amid divisions within the Democratic Party and skepticism a roughly 18.4 cent-per-gallon discount would be passed on to consumers….  In private meetings with senior Energy Department officials to discuss ideas for boosting supply and lowering prices, some industry representatives have instead used the sessions to push for longer-term priorities like building pipelines and easing environmental restrictions.”  “Politico: White House-Biden-gas prices”

“Rep. Kim Schrier, D-Wash.,… called it “infuriating” that spikes in gas prices were “happening at the same time that gas and oil companies are making record profits and taking advantage of international crises to make a profit. This must stop.″ “PBS: House approves bill to combat gasoline price gouging”

When the supply of a product falls short of its demand, the gap can be closed in one of two ways. Both involve rationing a scarce commodity as is required for anything in limited supply which is virtually everything. The first approach—the market approach of price rationing—allocates the product to those who want it the most, i.e. those who are willing to pay the most for it. The second approach—the administrative allocation approach—allocates the product to those the government agency responsible for choosing who gets it, determine are most worthy or in most need of it based on the criteria the agency sets (which in practice invariably includes friends and relatives). History has clearly documented which of these methods of allocation works best.  Some of you will remember the long lines at gas stations when President Richard Nixon capped gasoline prices (another form of rationing).

That leaves measures that encourage increased supply from everywhere except Russia or that facilitate reducing demand. “Biden officials are openly pleading with Big Oil to pump more, not less. ‘We want them to get their rig counts up. We want them to increase production so that people are not hurting,’ [Energy Secretary Jennifer] Granholm said.”  “CNN: Gas prices-Biden-inflation” A higher price at the pump provides the market a strong incentive to increase supply, but that generally takes years to achieve much of an increase. In the interim profits of the suppliers will be higher than usual.

Some months back policy sought to reduce the consumption of carbon omitting products as part of our effort to slow global warming. For that objective an increase in gasoline prices would be a good thing, whether from a gas tax or restrictions on finding and pumping more oil out of the ground.

For the moment, encouraging more production by Saudi Arabia and other (non Russian) members of OPEC would be helpful. Finally rejoining the JCPOA (Iran deal), Trump’s withdrawal from which Max Boot called the “single worst diplomatic blunder in U.S. history” “WP: Trump-Biden Iran nuclear deal dead with no alternative”, would, among other important things, increase an important source of oil supply, as would dropping sanctions on Venezuela. If we can make deals with Saudi Arabia, given all it has done, deals with Iran and Venezuela should be no brainers.

Ending the war in Ukraine promptly is the most important measure for addressing the shortage of oil (and food more generally). “End the war in Ukraine”

Economic Sanctions

Economic sanctions can be a political tool to punish and hopefully stop or deter bad behavior by another country, group, firm, or individual. However, sanctions are rarely effective, often hurting the wrong people. Robert Pape’s examination of past sanctions on countries found that only 4% were clearly effective. Their virtue is that they tangibly register disapproval of bad behavior without going to war. An important policy question is when to use them. In my opinion sanctions should be used very rarely against countries when there is a broad global consensus that the behavior of the country is significantly and unacceptably at variance with established international norms. This is both because they are rarely effective, in part because they often hurt the general public rather than the leaders responsible for the bad behavior, and because it should generally not be the business of our government to dictate how other governments behave unless that behavior is directly against us. What that means, for example, is that sanctions should not generally be used against countries whose human rights behavior we disapprove of.

Under what circumstances might the use of economic sanctions be justified and effective? The effectiveness of economic sanctions varies greatly with their nature and the circumstances in which they are applied. In what follows I very briefly illustrate the range of experience and possibilities.

Cuba

Clearly the sanctions of one country against another, such as outlawing trade in certain products or outlawing trade and financial transactions of any sort, are of very limited effectiveness as the sanctioned country can simply trade with others instead. Cuba illustrates this point. First imposed over 50 years ago by President John F. Kennedy and now enforced through six different statutes, the United States forbids most trade with Cuba by its citizens or companies. President Bill Clinton extended and stretched the reach of this embargo to apply to the foreign subsidiaries of American companies as well. The purpose of this embargo as stated in the Cuban Democracy Act of 1992 is to encourage the Cuban government to move toward “democratization and greater respect for human rights”.

Though the U.S. has put a lot of pressure on other countries to restrict their own trade with and travel to Cuba, it has been largely ignored. The U.S. pretty much stands alone. The cost of the embargo has fallen more on the U.S. than on Cuba. The U.S. Chamber of Commerce estimates the cost to the U.S. economy at $1.2 billion per year in lost sales and exports. More over it has not improved governance in Cuba nor led to regime change. In 2009, Daniel Griswold, director of the Cato Institute’s Center for Trade Policy Studies, criticized the embargo by stating:

“The embargo has been a failure by every measure. It has not changed the course or nature of the Cuban government. It has not liberated a single Cuban citizen. In fact, the embargo has made the Cuban people a bit more impoverished, without making them one bit more free. At the same time, it has deprived Americans of their freedom to travel and has cost US farmers and other producers billions of dollars of potential exports.” Former Secretary of State George P Schultz called the embargo “insane.”

Cuba is a mess not because of U.S. sanctions but because of the highly repressive Marxist regime in control for the last 52 years. The American embargo has given the Castro government an escape goat for its own failures—and the Castro government still rules. President Obama recently reestablished diplomatic relations with Cuba but the embargoes will remain until Congress amends or removes them. The President has been criticized for not getting enough in return for reestablishing relations and its link with Cuba’s freeing of American spy Alan P. Gross is certainly unfortunate, but the U.S.’s diplomatic recognition of a country should have nothing to do with whether we approve of its government and its approach to governing. The 50 plus year-old embargo has totally failed in its objectives as well, which were not justified in any event. It should finally be lifted and we, and our government, should continue to criticize the Cuban government’s oppressive and destructive policies.

Iran

Economic and financial sanctions against Iran have been more successful. Though the U.S. initially imposed limited sanctions following the Iranian revolution in 1979, international sanctions were imposed by the U.N. Security Council in 2006 and later by the EU in response to Iran’s refusal to suspend its uranium enrichment program. These sanctions banned supplying Iran with nuclear-related materials and technology, and froze the assets of key individuals and companies related to the program. In the following years these sanctions were expanded to include an arms embargo and broader freezes on assets held abroad and monitoring the activities of Iranian banks, and inspecting Iranian ships and aircraft.

These sanctions have reduced Iran’s export (largely oil) revenue and sharply restricted its imports of materials needed for its uranium enrichment program. The international arms embargo has negatively impacted Iran’s military capacity as it is now reliant on Russian and Chinese military assistance. The U.S./EU embargo on oil shipments was made more effective when the EU extended its embargo to ship insurance resulting in most supertankers refusing to load Iranian oil. Excluding Iran from international payments via SWIFT has significantly complicated such payments. The value of Iranian rial plunged by 80% and the standard of living is suffering.

While smuggling has allowed wide spread evasion of many restrictions, they significantly raise the cost of, and thus reduce the gains from, trade. In the list of unintended consequences, Fareed Zakaria argues that sanctions have strengthened the state relative to civil society because in Iran the market for imports is dominated by state enterprises and state-friendly enterprises, thus smuggling requires strong connections with the government.

While it is difficult to assess the impact of sanctions on public attitudes, they seem to be succeeding in increasing pressure on the government to reach an agreement with the U.S. and EU to reign in its uranium enrichment program. This qualified success reflects the broadly accepted purpose for the sanctions (thwarting Iran’s nuclear weapons potential), and hence broad (but not universal) enforcement of such sanctions.

Islamic State — Da’ish

Da’ish is not a recognized state but is so widely seen as an evil pariah that it constitutes an entity and cause for which sanctions should have their maximum impact. Moreover it is being resisted and attacked militarily as well. While direct U.S. military engagement would be counterproductive in the long run (it is their region and interest, not ours), logistical and weapons support to the government of Iraq and close coordination with Iraq’s neighbors has been and will be helpful. Blocking every possible source of income, payments, and weapons procurement by Da’ish will gradually degrade its ability to fight and to hold on to the territory it needs to fulfill its Islamic caliphate objective.

When virtually the whole world is behind sanctions, we have many tools and capability to make them effective. But even in this most obvious and potentially effective case, there are challenges. While strongly and rightly defending the right of anyone to offend the Prophet or anyone else we can hardly forbid public statements in support of Da’ish. The British “human rights group” CAGE, for example, is under attack for calling Jihadist John “a beautiful young man.” The group, led by former Guantanamo Bay inmate Moazzam Begg, is being attacked by both public and private groups in the UK for its jihadist sympathies. Similar issues exist in the U.S. Read more: http://www.dailymail.co.uk/news/article-2972757/Fury-charities-fund-ISIS-Jihadi-John-apologists.html and http://www.bbc.com/news/uk-31657333

But what about financial support to terrorist groups from their sympathizers? Striking the right balance between fighting terrorists and freedom of expression will require care. Who of my generation can forget the controversies raised in the 1970s and 80s over the financial contributions of Irish Americans and their charities to the Irish Republican Army (officially a terrorist group)?

Russia

In general, the modern world is blessed with many positive incentives for people and countries to behave well. The broadly embraced values of the Enlightenment, and classical liberalism’s respect for each individual and his and her rights has established a presumption against force and coercion and hence against war. It is far more profitable (for both sides) to buy what we want than to try to take it (trade vs war). But unfortunately this has not always been enough to deter bad behavior necessitating consideration of deterrents. Russia’s President Vladimir Putin, whose behavior I can only understand as that of a self enriching gangster who is happy to exploit the fears and paranoia of the average Russian to enhance his power and control, but who cares little for the future well being of his country, is grossly violating post Westphalian principals of sovereignty. Our interest in Ukraine is marginal and Putin’s is intense for reasons of Russian history and its emotional value for Russian support of its new autocrat. U.S. intervention of any sort in Ukraine would likely precipitate intensified interference by Russia. Where and when would the escalation on each side end? Would Russia’s bankruptcy end the fighting before reaching the nuclear level? We should not try to find out. Whether we should provide the pro west Ukraine government with defensive arms is a more difficult question, but would risk ill-advised escalation by Ukraine, a risk we should not take. This leaves us with economic sanctions as the most appropriate deterrent of Russia’s bad behavior.

Interestingly and frustratingly the vary interdependencies that develop with trade also create weapons that can be used by either side to promote a country’s aims. Da’ish is not in a position to deprive us of anything in retaliation to sanctions we impose on it. Even shutting down all exports of oil in the territories it controls or is likely to control would be barely noticed. On the other hand, Russian threats to shut off the flow of oil and gas to Europe and especially Germany, which receives 40% of its oil from Russia, must be taken very seriously. All of the natural gas consumed in Estonia, Finland, Latvia, Lithuania, and Macedonia comes from Russia as does over 50% in Bulgaria, Czech Republic, Greece, Hungary, Montenegro, Serbia, Slovenia, Turkey, and Ukraine. A Russian cut off of gas and to a lesser extent of oil would be devastating to Europe. On the other hand, the loss of that revenue would be devastating to Russia. This is the two-sided nature of trade. It introduces caution into measures to harm trading partners.

Russia’s recent deal to supply oil and gas to China will reduce its reliance on its European market and hopefully Europe will also take steps to reduce its reliance on Russia. However, the U.S. has moved slowly if at all to increase its capacity to ship gas and oil to Europe, which is currently heavily dependent on existing pipelines from Russia. Russia has spent billions of dollars in Europe through environmental groups and others to discourage the development of Europe’s oil shale potential and to encourage the reduction of its use of nuclear energy. http://www.thenewamerican.com/world-news/europe/item/18546-nato-head-russia-is-funding-anti-fracking-movement http://www.washingtontimes.com/news/2015/feb/2/richard-rahn-vladimir-putin-funding-opposition-to-/

Sanctions so far have been carefully (and wisely) targeted to a few specific individuals and companies. It is difficult to determine whether they are having any effect on Putin’s behavior. If they are increased, the risk of Russian retaliation will increase as well, the burden of which would fall on Europe, not the U.S. Russia has cut off the flow of its gas and oil to Europe before for relatively short periods but has resisted doing so for the last few years. Putin is now threatening it again: http://www.washingtonpost.com/world/europe/putin-threatens-to-cut-gas-to-ukraine-as-showdowns-shift-to-economy/2015/02/25/b0d709de-bcf6-11e4-9dfb-03366e719af8_story.html.

Putin’s behavior justifies increasing sanctions but they should remain well targeted. A total blockade of Russia, which would be extremely difficult for Europe, would lead to a collapse of the Russian economy with unpredictable political consequences. The collapse of the Soviet Union in 1991 following the end of the cold war in December 8, 1987, with the signing of the Intermediate Nuclear Forces (INF) Treaty launched the transition (for a while) to a more liberal regime. It was the most dramatic and totally peaceful regime change the world has ever seen, but it took 70 years of patience to achieve. In a letter to this week’s Economist former British Ambassador to Russia Sir Tony Brenton said: “The solution to the Russia problem is not to sanction and isolate, but to hug close and thus, eventually, subvert.” We have a strong interest in an orderly political transition in nuclear-armed Russia.

Israel

Ironically the opposite side of the page of the Washington Post story on Russia linked above reported on the very disturbing use of economic sanctions by Israel against the Palestinians living in the West Bank. Israel refused to turn on the promised water to a new upscale city (residences, shopping mall, theater complex, sports club, school, etc.) being built on a West Bank mountaintop. “Before granting water access to the planned city of Rawabi, Israel — which controls the area that the water pipe would run through — wants Palestinian Authority officials to return to an Israeli-Palestinian Joint Water Committee. The Palestinians abandoned the group in 2010 because they don’t want to approve water projects to Jewish settlements in the occupied West Bank, which are built on land that Palestinians want for a future state — and which still get plenty of water.” http://www.washingtonpost.com/world/middle_east/new-palestinian-city-has-condos-a-mall-and-a-sports-club–but-no-water/2015/02/24/d5a28dcc-b92e-11e4-a200-c008a01a6692_story.html

After driving Palestinians from their homes in the war of 1948 that established the Jewish state of Israel, the new state of Israel and the international community accepted boundaries between Israel and the rest of Palestine that were somewhat enlarged from the UN approved partition of Palestine into Israel and the West Bank and Gaza Strip. The right of the 700,000 displaced Palestinians to return to their homes remain one of the unresolved issues in the Israeli-Palestinian dispute. The Jewish settlements referred to above are in the West Bank and have been ruled illegal in a number of UN resolutions and U.S. State Department opinions. http://works.bepress.com/warren_coats/26/

On several occasions Israel has also withheld the import tariffs that it collects on behalf of the WBG government (the Palestinian Authority) in order to pressure the PA not to challenge the construction of additional illegal settlements in the West Bank. “To protest the Palestinian Authority’s move this year to join the International Criminal Court in The Hague, Israel has also withheld for three months the transfer of $381 million in custom duties Israel collects on Palestinians’ behalf.” http://www.washingtonpost.com/world/middle_east/israel-to-let-water-flow-to-west-bank-development-at-center-of-political-feud/2015/02/27/d1b598de-be84-11e4-bdfa-b8e8f594e6ee_story.html

These are examples of a country’s use of “sanctions” to achieve its own, not widely shared, political ends. In the New York Times Nicholas Kristof said: “The reason to oppose settlements is not just that they are bad for Israel and America, but also that this nibbling of Arab land is just plain wrong. It’s a land grab.” http://www.nytimes.com/2015/02/26/opinion/nicholas-kristof-the-human-stain.html?_r=0 The same can be said of Russia’s land grab in Ukraine.

Fortunately in the case of Israel, Prime Minister Netanyahu intervened on February 27 and approved turning on the water before traveling to the U.S., presumably worried about bad press from Israel’s behavior, something President Putin unfortunately but predictably doesn’t seem to care about.