Economic Diplomacy Boom: Will It Last Long?

As the international crisis around Ukraine escalates, countries in the West, especially the United States, have increasingly used economic diplomacy against Russia, and threaten to expand the scale and reach of sanctions. Sanctions have also been a key mechanism by which America exerts pressure on Iran and many other countries. Why are these tools of economic coercion increasingly becoming a basis for pursuing the policy of containment and the main instrument of Western countries’ pressure?

As the international crisis around Ukraine escalates, countries in the West, especially the United States, have increasingly used economic diplomacy against Russia, and threaten to expand the scale and reach of sanctions. Sanctions have also been a key mechanism by which America exerts pressure on Iran and many other countries. Why are these tools of economic coercion increasingly becoming a basis for pursuing the policy of containment and the main instrument of Western countries’ pressure? Is it because economic diplomacy is so effective compared to other instruments of foreign policy? Or is there a different reason for so frequently resorting to economic instruments of foreign policy?

Economic diplomacy (economic statecraft) is the use of the full spectrum of economic tools a state has at its disposal to achieve its foreign policy goals. Instruments used in economic diplomacy are divided into the negative (sanctions) and the positive (rewards), and can take many forms. The most well-known being economic sanctions, on the one hand, and various “rewards for loyalty”, including economic and military aid, access to markets, etc., on the other [1].

Economic diplomacy’s place in the foreign policy arsenal

States pursue foreign policy and protect their national interests through a variety of instruments. Foreign policy tools that the state has at its disposal can be divided into several groups as follows: information – propaganda, timely and properly delivered facts; soft power – attractiveness of its socio-economic model, national culture; diplomatic – negotiations, agreements and alliances; power – threat of violence, violence; economic – goods, services and investment; monetary – access to markets.

It is necessary to draw a line between economic instruments of foreign policy and a state’s foreign economic policy. The fundamental difference between the two is that economic tools of foreign policy are used to achieve non-economic objectives, while foreign economic policy, in contrast, uses economic and non-economic instruments to achieve the economic goals of the state. The following example illustrates the difference between these two categories.

Imposing a trade embargo against a country to force it to abandon its WMD development programs is categorized as economic diplomacy [2]. The use of political pressure to force a country to reduce import restrictions is categorized as foreign economic policy. The American embargo against Cuba illustrates an unsuccessful attempt to use economic sanctions for political purposes. The introduction of countervailing duties by the United States in response to Chinese subsidizing exports of auto parts in 2012 illustrates the use of sanctions for commercial purposes. Of course, it is not always possible to distinguish between these two types of public policy, since the states often pursue both political and economic goals simultaneously.

Economization of foreign policy began not so long ago

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The world's shifting trade winds

Economic instruments of foreign policy occupied a prominent place in the foreign policy arsenal of economically developed countries after World War II, when the global trade in goods and services started developing rapidly [3].

Many countries, particularly the United States, saw the growth of international trade as an excellent opportunity to exert influence on foreign governments. In the 1990s, the United States and other economically powerful countries obtained operating control over an important foreign policy tool. Encouraging or limiting foreign countries’ participation in global economic processes made it possible to attain major foreign policy goals without resorting to military force, when traditional diplomatic methods had failed. The possibility of using economic measures is determined by the economic vulnerability of the state and the type of foreign-trade policy that it pursues. It is difficult to exert influence on a state such as North Korea, as its foreign trade is negligible. On the other hand, it is easy to assert influence over a country that imports all vital goods and does not produce any of them itself.

Foreign economic instruments at states’ disposal today include international trade and economic sanctions, establishing regional trade blocs and regimes, managing international financial flows and the use of external debt, the use of foreign direct investment, economic and humanitarian aid, as well as influencing the activities of international financial institutions. Financial instruments of foreign policy are today becoming more important than those involving trade. Thus, forty years of trade sanctions could not force Iran to reconsider its position on the nuclear issue, while financial sanctions imposed by the West were quick to bring Iran to the conference table.

Improved efficiency of using financial instruments in the world economy is primarily due to the peculiarities of the current stage of globalization. The volume of financial transactions heavily exceeds the amount of financial services rendered in the international trade in goods and services. In 2013, global exports of goods and services amounted to 17.8 trillion dollars [4], while the volume of the world equity market alone (excluding bonds, derivatives, currencies) amounted to $55 trillion [5]. The globalization of trade has diversified world markets, except for certain specific goods (such as weapons, some high-tech products, and gas). Goods can be bought and sold in many markets, which makes manipulating the commodities markets for political purposes increasingly difficult. In contrast, the global finance system becomes increasingly vulnerable to targeted interference. The number of global reserve currencies used in international transactions is decreasing, and corresponding accounts are settled in the three or four centers that service an increasing share of the world economy. 90 per cent of FOREX transactions and 80 per cent of trade finance world over was conducted in American dollars [6].

The combined use of trade and financial pressure mechanisms appears a particularly effective political tool to promote a state’s foreign policy interests.

Not all players enjoy the opportunity of using economic instruments (financial and commercial) in foreign policy to protect their interests in the modern world. Minor economies are helpless in a world scarred by political struggle, just as militarily weak countries cannot use military power to advance their political interests.

The successful application of economic instruments requires at least partial control over the “commanding heights” of the world economy, such as the world reserve currency, a major financial and payments center, strong positions in international economic organizations that provide an opportunity to use not only one’s own financial resources, but those of other countries too (that are managed by international financial institutions) to its political ends. Most of the sanctions that proved politically successful were imposed by the United States, although there were instances of successful sanctions imposed by other countries (the UK against Rhodesia in 1966). In contrast, the Russian sanctions against Georgia and Moldova in the mid-2000s failed to achieve their political goals, although they were relatively economically successful.

Sanctions as the main tool of economic diplomacy

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After World War II, the practice of imposing economic sanctions gained momentum. In 1950, there were 15 cases of the imposition of sanctions, in the 1960s – 20 cases, in the 1970s – 37, in the 1980s – 23, and more than 50 cases in the 1990s. Most were imposed unilaterally by the United States, and in recent years countries in Western Europe began to apply sanctions more actively, although such sanction coalitions have usually been formed by the United States [7].

The attitude of governments and international public opinion towards the issue of when sanctions are justified and appropriate has changed over the last decade. From the beginning of the First World War to the end of World War II, sanctions were imposed to prevent military intervention, and as a part of the government’s broader war effort. In subsequent decades, the spectrum of ends to be achieved by imposing sanctions widened and included putting an end to regional conflicts, promoting the spread of democracy and political freedoms, enforcing human rights, preventing the proliferation of nuclear weapons, winning the release of hostages and the liberation of occupied territories.

The efficiency of trade and economic sanctions as a political tool has long been seriously discussed. More and more experts [8] tend to believe that sanctions are not effective in principle. Nonetheless, sanctions remain a favored tool of politicians and the frequency with which sanctions are imposed around the world does not decline.

The reason for this decline in the efficiency of economic sanctions should be sought in the nature of the modern globalized economy. The world is becoming, and in many ways has become, a single market, and the relative dominance of the American economy and the economies of its political allies in the world is weakening. The United States and the West as a whole have lost a significant part of their control over and influence on the world economy and trade in goods and services. Since, historically, most economic sanctions were imposed by them, the effect of their imposition has consequently also lessened. Great Britain’s share of global merchandise exports fell from 18.5 per cent to 2.6 per cent (2012), the share of Germany – from 18 per cent to 7.7 per cent [9], and that of the United States decreased from 12.56 per cent in 2000 to 8.21 per cent in 2012 [10].

Globalization has had a twofold impact on the use of sanctions in world politics. On the one hand, globalization diversifies export and import markets, making the effective imposition of sanctions more difficult, since any state can find alternative tracks for exports and imports. On the other hand, the financial and information components of globalization make it easier to track international payments and financial flows, providing developed countries with world reserve currencies better opportunities to meddle in world trade finances and block trade operations. This is why, in recent years, the emphasis on the imposition of economic sanctions has shifted from trade sanctions to financial sanctions. In terms of financial sanctions, limited access to the capital markets has come to the fore.

Thus, the relative decline in the efficiency of trade and economic sanctions is largely due to the global nature of the world economy, which offers little if any opportunity for the introduction and maintenance of truly severe restrictions on the flow of goods and services, except for specific groups of goods, such as weapons, dual-use technology, etc. Another reason for sanctions’ limited effectiveness is that they impact the population of the target country rather than its political decision-making elite. In a democratic society the political elite, aware of public discontent sparked by a drop in living standards, is likely to react by taking the required decision. The elite in authoritarian political systems, against which sanctions are most often imposed, remains unaffected by sanctions and can afford to ignore them. The imposition of sanctions against Iraq under Saddam Hussein serves as an apposite illustration of this point.

Reasons for economic diplomacy

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Why has economic diplomacy come to the fore in world politics in the last 20-30 years, becoming a staple instrument of Western foreign policy?

This change was brought about by political, military, social and economic factors.

Restrictions on the use of military force are an important obstacle to conducting foreign policy via traditional coercive methods. The use of military force is not only restrained by international law and institutions (the UN Charter, the UN Security Council), but, more importantly, by the substantial conventional military power and nuclear weapons that many countries hold in their arsenals. Only weak countries can be attacked largely painlessly, while major global and regional powers are almost immune to the use of military force from outside.

The second factor that makes economic diplomacy so popular is that politicians, executives and legislators like such methods. They are in every way less expensive than military action, do not antagonize people who do not want to take up arms and go to the front, and they seem relatively humane: there is no bloodshed on TV, no reports of mass casualties. Of course, some national manufacturers may suffer losses as a result, especially if they are exporters, but imposition of sanctions is not regulated by international law, so the authors of the sanctions do not have to enter into a conflict with international law. In short, economic diplomacy seems a much more comfortable and politically acceptable method than war.

The third reason why economic diplomacy is so widely used today is ideological in nature. The West, in the broad sense, stands for a liberal worldview that highlights the interests of the individual. One of the basic interests of the individual appears to be the benefits and maximum possible consumption provided by free trade. The imposition of economic sanctions reduces consumption, makes the consumer market more expensive and sparse. However, the political effectiveness of this economic pressure depends not only on the worsening economic situation, but also on the society in question’s commitment to the ideals of private gain and consumption, quite apart from the political regime’s readiness to consult private interests of its citizens. In this regard, society in different countries differs greatly, and a prime example of this is Cuba and Iran, which for decades lived under sanctions.

The same is true for stimulating economic instruments of foreign policy. There are many states that are ready to make political concessions in exchange for economic benefits, while there are few examples to the contrary. Ukraine, which refused a giant package of economic assistance offered by Russia for political reasons, is one of them.

The status quo is becoming less acceptable to emerging powers, and they (the BRICS, for example) are beginning to build an alternative global financial architecture and to form their own rules for international trade and investment. It seems that these efforts are starting to yield their first results. For example, the decision was taken to set up the New Development Bank (NDB) [11]. This means that economic diplomacy in its current form will face new restrictions. It is becoming increasingly difficult to implement economic diplomacy in a world of alternative finance, trade and investment using the traditional economic stick and carrot policy, and regional economic integration projects are coming to the fore today as tools of global political and economic competition.

In my view, the sanctions will remain in the arsenal of world politics, although their political effectiveness is increasingly contested. The U.S. President argues that Russia's policy toward the Ukrainian crisis has changed as a direct result of the sanctions. There might be an element of truth in his words, but it is also true that the situation in South-Eastern Ukraine today is much more in line with Russia's interests than it was a month ago.

There will be attempts to dispute the sanctions and the counter-sanctions in international courts and the WTO.

It will be interesting to watch as events develop, but drawing up internationally recognized rules on the issue of sanctions seems unlikely.

1. See: M. Braterskij. Nevoennye rychagi vneshnej politiki Rossii. Regional'nye i global'nye mehanizmy. Moscow, 2012, p. 78.

2. B. Steil and R.E. Litan, Financial Statecraft. Yale, 2006

3. Growth in world trade became particularly intense in the late 20th century. In 1986-2000, the volume of world trade in goods and services nearly tripled.

4. http://stats.oecd.org/index.aspx?queryid=167

5. http://www.world-exchanges.org/files/2013_WFE_Market_Highlights.pdf

6. http://www.bloomberg.com/news/2014-07-15/dollar-dominance-intact-as-u-s-fines-on-banks-raise-ire.html

7. See: Gary Clyde Hufbauer , Jeffrey J. Schott , Kimberly Ann Elliott and Barbara Oegg . Economic Sanctions Reconsidered. N.Y., 2008

8. See: K.A. Elliot, G.C. Hufbauer, B. Oegg, Sanctions, http://www.econlib.org/library/Enc/Sanctions.html, pp. 1-15; V. Dimitrijevic, Sanctions, Regime and People, Review of International Affairs, 1993 pp. 11-12.

9. See: Address by Deputy Minister of Economic Development A.E. Likhachev to the Federation Council on September 9, 2013

10. See: http://wits.worldbank.org/

11. Joint Statement of the Fifth BRICS Summit in Durban, March 2013 http://www.cfr.org/emerging-markets/joint-statement-fifth-brics-summit-durban-march-2013/p30341