Tuesday, August 12, 2014

If goods don't cross borders, armies will

Published on Zero Hedge

While the conflict in Ukraine rages on, EU member states have decided to impose (not so much more stringent) economic sanctions against Russia, which was predictably followed by Russian counter-measures. The question which isn't being asked often enough, is whether these sanctions will actually improve the situation. Here's an analysis following four concrete questions: 

1. Can things get even worse in Russia?
2. Is the West able to guide Russia and Ukraine down the right path?
3. Can the West contribute to a sharpening of the crisis?
4. How can the West protect itself against this conflict?

1. Can things get even worse in Russia?

Of course. That answer may seem evident, but many analysts implicitly assume that there really are no worse alternatives for the Putin regime. That Russia has an authoritarian regime, is an understatement. At the moment there even is a power struggle ongoing between Kremlin hardliners and business leaders, according to the BND, Germany’s intelligence service. Nevertheless, Putin is some kind of a moderate in Russia, at least when judging his approval rate, which would be around 80%, the highest in six years. Even if Putin's real domestic support would be a lot less strong in reality, it's clear that there are a lot of radical alternatives. Putin doesn’t mind to associate himself with some of them, for example the ultra-nationalist ideology Aleksandr Dugin. Such pressures on Putin partly explain aggressive policies, like the Crimean invasion. 
The primary reason for the support Putin enjoys for his Ukrainian ventures is of course the Russian minority. Many in Russia do not consider Ukraine to even be a country. That Russian minorities in Latvia aren't always treated fair and equally, makes it easier for Putin to justify intervention. One of the first measures of the new Ukrainian government was to no longer allow Russian, the mother tongue of about a quarter of the population, to be used as a regional governance language, an enormous PR failure, although the measure was quickly vetoed by interim President Oleksandr Turchynov. Recently, the Ukrainian government has banned Russian films and the Communist Party. The latter convinced 13% of the electorate in 2012 and supports decentralisation of the country. Its stronghold is located in the South East, where a lot of Ukrainian Russians live, and it has spoken out against the military offensive of the Ukrainian army, which was recently also criticised by Human Rights Watch for killing 16 civilians with unguided rockets.

As a result, it could be expected that Putin would intervene, although perhaps not by eurocrats like European Commission President José Manuel Barroso. During the negotiations on the EU-Ukraine Association Agreement, the EU basically forced the divided country to choose between Russia and the EU. Barroso himself stated in February 2013: "One country cannot at the same time be a member of a customs union and be in a deep common free-trade area with the European Union,", referring to Putin's Eurasian Economic Union. That's the result of the general lack of flexibility the EU employs in its relations with non-EU member states, something which certainly has played a role in the worsening of this crisis. A similar all-or-nothing framework has contributed to worsening relations with Turkey. The Commission had a mandate to conduct trade talks with Ukraine, but basically used this to conduct foreign policy, even challenging the Kremlin. This annoyed EU member states, which meanwhile have taken over, pushing the EU's High Representative for Foreign Affairs, Cathy Ashton, aside. The EU, which is strongly divided, should stay away from foreign policy as far as possible, certainly with regards to the sensitive relationship with Russia, where a risk of escalation is certainly present. After a monster fine of $50bn was imposed on Russia for nationalising Yukos, the Financial Times quoted an anonymous source close to Putin saying: “There is a war coming in Europe…Do you really think this matters?”

2. Is the West able to guide Russia and Ukraine down the right path?

The West could at least try not to make matters worse. Despite the mistakes which were made before the crisis by the EU, it sent an appropriate signal by unilaterally abolishing a few trade barriers for products from Ukraine. This angered agricultural lobbyists in Brussels, always happy to impose costs on consumers or taxpayers.

Unilateral opening of borders for trade is only a bad thing for those who think that trade "costs" something. The opposite has been proven over the centuries. Certain producers with good political connections in protected economic sectors may of course face more competition, but consumers enjoy lower prices and more freedom to choose, and that's what counts.

The opening to China made by US President Richard Nixon probably was the most succesful example of foreign policy in the second half of the 20th century, along with the treatment of post-war Germany. Without waiting for China to abolish its protectionism, such as the obligation for investors to enter into "joint ventures", the U.S. allowed entry for Chinese products. About half a billion Chinese were lifted out of extreme poverty in less than 40 years and Western consumers enjoyed lower prices. On its turn, this helped to deal with factory closures in Western economies which can only partly be blamed on foreign competition. Excessive regulation and tax pressure are the real culprits, also preventing the creation of sufficient new enterprises to replace the disappearing old industry.

On the long term, there is only one strategy which has proven to be succesful: opening borders for trade. That Ukraine wants to leave the Russian sphere of influence, is in this respect no coincidence. The country's economy is less dependent on natural resources (5%) than for example Kazachstan's (32%). An independent critical middle class only emerges in countries where it's hard for the government to get a grip on the economy. It never emerges when the regime merely needs to control the natural resources and no significant economic activity outside of governmental control exists.

3. Can the West contribute to a sharpening of the crisis?

As explained, the West could open its borders for trade with Ukraine and Russia, in order to support the development of a critical middle class on the long term. That would be a modest but effective contribution to the situation in societies which are hard to influence from abroad.

For Western countries, it’s however also perfectly possible to make sure that the crisis deteriorates. There is a policy which fails time over time, apart from the odd occasion when it works, just like a broken clock works twice a day: economic sanctions.

- North Korea, more an open air prison than a country, is still isolated. Years of sanctions have prevented a Chinese or Vietnamese scenario, with gradual liberalisation which also profits the regime, thanks to the gains of external trade.

- Also in the case of Iran and Libya under Gaddafi did sanctions prevent a real improvement of relations with the West. They failed to undermine the regime domestically, on the contrary. That's a pity because the "Persian nation" should be a more natural ally in the region than Saudi Arabia, which is even less secular and because Libya harbours the biggest oil reserves in Africa. Anyhow, understandable aversion against the two regimes has been trumping all other considerations. The illusion prevailed that blockades and force could convince countries without any democratic tradition to adopt better practices.

- Sanctions and wars, the former’s continuation by other means, against the Iraqi tyrant Saddam Hussein, have resulted in turning one of the most secular countries of the Middle East into a true hellhole where the "Islamic State", a group even more murderous than Al-Qaeda, controls large parts of the territory.

- Then we even haven't discussed Cuba. It's simply a waste of time to explain why the country would for long have been flooded by American investment and capitalism if the senseless embargo against the economically and morally bankrupt Castro-regime would have been lifted.

- Sanctions against South-Africa, which were supposed to help end apartheid, were introduced in 1963. That was 30 years before the system was abolished, meaning that the link between sanctions and the end of apartheid was weak at best. Some analysts contend that the sanctions even proved to be a boon for the ruling regime. ARMSCOR, the government's arms procurement agency, was established primarily as a response to the sanctions and developed a capability which far exceeded South Africa's requirements. Because of the many jobs dependent on it, the regime would have enjoyed support from a key constituency that directly benefited from the sanctions. 

- The policy also failed in Zimbabwe. Sanctions introduced in 2002 targeted the regime of the grim dictator Robert Mugabe. He’s infamous for taking up the policy of "quantitative easing" a little too enthusiastically, subjecting his population to a period of hyperinflation. He’s still in charge, throwing parties while unofficially unemployment data would be above 90%. This year, the Belgian ambassador to South Africa, Johan Maricou, demanded an end to the sanctions, explaining that "they are counterproductive, because Zimbabwe's regime uses them to explain everything which goes wrong in the country."

- A last example is Burma, where it took 20 years after sanctions were introduced before things started moving in the right direction. The regime introduced liberalization, reacting to domestic protests from 2007 on. No link with the policy of sanctions can be witnessed.

Despite the many failures of economic sanctions, everyone is of course free to believe that this time around, it will be different.

In a comment in support of economic sanctions, The Economist - the newspaper which in 1854 was still railing against those attempting to stir up war in Crimea - was only able to cite a few obscure succesful examples of the policy. One is how it would have forced Iran back to the negotiating table during its recent cyberwar with the U.S., to discuss its nuclear programme. That sanctions have motivated Iran, is not certain at all and either way no improvement in the Iranian relationship with the West can be witnessed since 1979, when the Ayatollahs rose to power and the U.S. imposed sanctions.

Research by academic Gary Clyde Hufbauer investigating all economic sanctions since 1914, concludes that these only "work" in 34% of cases, while they only succeeded in 20% of occasions to disrupt relatively minor military adventures where that was the goal. Those who favour the current measures against Russia should reflect upon the researcher’s findings that apparently, politically or economically weak countries are more vulnerable and that the more sanctions cost the country imposing them, the less likely it is that they will succeed. To do nothing is indeed sometimes better than "to do something", certainly when it's likely that the latter would make the situation even worse. 

When Putin became President again, he made it into one of his goals to "nationalise the elite", thereby forcing those in his inner circle to sell off foreign assets, so they would be less vulnerable and more loyal in case of international tension. None of the five or six former KGB-cronies in Putin's inner circle would still have any foreign assets.

Is there anyone who believes that Russian oligarchs, the only ones who still may have a certain degree of independence from Putin to speak out, would try to stop him if they would no longer have any more assets abroad? Mark Champion, the former bureau chief of the Wall Street Journal in Brussels, points out that if tough measures against Russia would be decided, "any future land grabs would incur smaller additional costs for Russia." American think tank Brookings Institution warns that Putin himself rowed back from modernizing Russia's economy from 2012 on, instead pursuing deluded goals as import substitution and autarky, a policy likely to be accelerated in case more sanctions are imposed. Tony Brenton, the former British Ambassador in Moscow, sums it up nicely: "The pressure on Western governments to “do something” has become acute (...) Economic sanctions (...) won’t work. We will have to negotiate with Vladimir Putin (...) In countries as prickly as Russia, sanctions simply strengthen the forces most hostile to the West. It has even become a badge of patriotic pride among senior Russians to be on the sanctions list. Every new round reinforces Putin’s standing with the public as their champion against a predatory West."

Perhaps it is also useful to quote Vladimir Putin himself. According to a biography published in 2000, he once stated: “You should never drive a rat into a corner."

Obviously, sanctions would succeed in damaging the Russian economy. According to Alexei Kudrin, who served as Putin's Finance Minister for eleven years, the Russian economy could collapse in six weeks time as a result of it. Also the EU could get in trouble. Southern European banks have a considerable exposure to Russia. The most vulnerable is Italian bank Unicredit, which also helps to explain the stance of the Italian government. Russia exports more to the Netherlands than to any other European country (16% of Russian export, mainly because Rotterdam serves as Russia's port to transfer its oil to world markets, as Russia doesn't have an ice free port). Either way, recent data show that the German economy, the motor of the continent, already suffered economic damage as a result of the tensions.

4. How can the West protect itself against this conflict?

The answer to this question naturally depends in the first place on whether this is an internal Ukrainian conflict, whether it's a Ukrainian-Russian war or whether there is a serious danger for the conflict to expand to Moldova or even the Baltic states, and to what extent this ultimately endangers security and stability in Western Europe. This issue raises the question whether it was such a good idea after all to adopt the Baltic states into NATO, and why a country like Finland isn't keen at all to join NATO, regardless of the isolated opinion of its new EU-federalist Prime Minister Alexander Stubb, who has also warned that sanctions would hit his country economically.

This issue leads us to comparisons between on the one hand Finland, which has a rather neutral, stable relationship with Russia, and on the other hand Poland and the Baltic states, who address Russia in a rather aggressive way, despite their strong energy-dependence from the country, hoping that their NATO - membership is more than just a piece of paper. At least Polish Foreign Mininster Radosław Sikorski seems to think it isn't. In a secret recording which was being leaked - perhaps by Russia, to undermine NATO cohesion - he stated: " "You know that the Polish-US alliance isn't worth anything (...) It is downright harmful, because it creates a false sense of security ... Complete bullshit. We'll get in conflict with the Germans, Russians and we'll think that everything is super, because we gave the Americans a blow job. Losers. Complete losers [, that's what we are]."

It's a good thing that these questions are being asked, because sooner or later we'll have to debate it. To give a clear answer, is however difficult, because it all depends on how public opinion in the West thinks about this, and what can be described as "the West". 

In my humble opinion, we can’t say there is any aggression against the West in the current conflict, certainly now that the U.S. have declared not to have any evidence of a direct Russian link to the attack on the Malaysian plane.

A majority of the population in Germany and Italy is against Ukrainian NATO - membership, so there isn't democratic support in Western Europe to defend the country in a military way. Only in 2010, 93% of Ukrainians said they regarded Russia in a positive light, which was six years after the Orange Revolution where anti-Russian sentiment was present. Now things are likely to be different, but it's hard to argue that this "conflict between brothers" can be described to Westerners as "our war". 

A policy of non-intervention isn't necessarily the same as naive pacifism. It's clear that this conflict could have a lot of indirect consequences for Europe and NATO-countries, which should at least lead to major attention for the efficiency of defense spending. It’s even clearer that any intervention in this conflict is extremely risky.
Diplomacy and maintaining effective defense capabilities can be the only answers. That's ambitious enough. Perhaps the way in which a country like Finland deals with Russia can offer lessons. Then I don't refer to "Finlandisation", which meant that the Soviet Union was involved in every major decision in the country, but to the policy after 1991. Since then, Finland clearly has sided with the West, but it has also maintained a good commercial relationship with Russia, not suffering from the illusion that it is capable of shaping Russia into the model its desires, otherwise than through trade, indirectly.

"Neo-conservatives" offer the ideological framework for economic sanctions and military interventions and would stem from reformed Trotskyists, who may no longer believe in bureaucratic planning of the economy but still think social engineering is possible in foreign policy. After the disastrous adventures in Iraq, Afghanistan and Libya, they should now grab the opportunity to remain silent. Sanctions and confrontation are dangerous. It is time for realpolitik.

Ultimately, we need to trust the following wisdom: “If goods don't cross borders, armies will”.

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