Friendly fire: the trade impact of the Russia sanctions and counter-sanctions

SUMMARY Economic sanctions are a frequently used instrument of foreign policy. In a diplomatic conflict, they aim to elicit a change in the policies of a foreign government by damaging their economy. Sanctions, however, are also likely to affect the sanctioning country. This paper evaluates these costs, in terms of export losses, for the diplomatic crisis between the Russian Federation and 37 countries over the conflict in Ukraine that started in 2014. We first gauge the impact of the diplomatic conflict using a traditional trade framework and quantify the trade losses in a general equilibrium counterfactual analysis. Losses for the Russian Federation amount to US$53 billion or 7.4% of predicted total exports from 2014 until the end of 2015. Western sanctioning countries, however, have also been impacted with an estimated loss of US$42 billion, 0.3% of their total exports. Interestingly, we find that the bulk of the impact stems from products that are not directly targeted by Russian retaliation, an effect that we coin friendly fire – an unintended, largely self-inflicted cost for Western sanctioning countries. We investigate the underlying mechanism at the product- and firm-level data. Results indicate that the drop of Western exports has not been driven by a change in Russian consumers' preferences, but mainly by an increase in country risk affecting international transactions with Russia.