By Donald L. Losman*
International economic sanctions entail the use of economic instruments by one nation to achieve certain objectives, usually political, from another. Typical actions include limitations upon or cessation of trade, aid, investment, or technology flows. Such efforts are designed to inflict economic damage, the hope being that such damage will then be translated into sufficient political pressure upon the target government that offending policies are modified or eliminated. This article notes the substantial in crease in American sanctions impositions, reviews the economic theoiy upon which sanctions are based, highlights the political and economic weak links in the sanctions chain that generally impede sanctions success, classifies the costs to target states and to the U.S. business community, and views some business actions that might be undertaken to minimize the disruptions and costs involved. From the perspective of bujiness organizations, these foreign policy tools are extremely disruptive and largely unpredictable, thus adding increased uncertainty and decisionmaking costs to already difficult calculations concerning overseas sales or production.
* Donald L. Losman is Professor of Economics, Industrial College of the Armed Forces, National Defense University, Washington. DC. This paper is adapted from one given at the 39th Annual Meeting of NABE. New Orleans, LA Septemberl4-17, 1997. The author wishes to thank the Association of the Industrial College of the Armed Forces for funding this research.
Use of various kinds of economic sanctions has a long history, even in the United States. Some prime twentieth century examples include our oil sanctions against Japan in the early 1940's, various measures against the Soviet bloc, and the continuing embargoes of Cuba and Iran. Importantly, in the past two decades our use of sanctions has increased substantially. Further, these sanctions are increasingly unilateral in nature. The United States is clearly the world’s most active sanctions-imposing countiy, much to the detriment of our firms that participate in world markets.
Recent trends are eye opening. In the four-year period spanning 1993-96, there were "61 laws and executive actions.. .authorizing unilateral economic sanctions"1 against thirty-five countries. These actions thus put an "off limits" sign on 42 percent of the world’s population and deprived U.S. businesses from participating in almost $800 billion of exports.2 (These numbers exclude participation in the multilateral sanctions against Iraq.) In 1996 alone there were twenty-three cases of sanctions imposition. The most common justifications for their employment include human rights violations, antiterrorism, nuclear nonproliferation, antinarcotics, political stability, and worker rights issues. In the spring of 1997, for example, Unocal had to give up development of two natural gas fields in Burma due to the latter’s human rights/ democratization failings. Two years earlier Conoco was forced to abandon its efforts in Iran.
This enumeration is conservative. For example, countries in which pre-1993 sanctions are still in effect are not included, nor are some environmental protection efforts ("24 countries whose shrimp has been embargoed.. .due to failure to use turtle-excluder devices in shrimp fleets"3). Also not listed is a very large potential group of target populations resulting from the newest wrinkle, secondary boycott measures.4 Although clearly contrary to the spirit, and probably the letter, of our own antiboycott legislation,5 secondary boycott measures were adopted in 1996 in connection with sanctions against Cuba, Iran, and Libya. Secondary boycotts are very incendiary actions that can easily evoke retaliatory measures against U.S. businesses.
In addition to federal actions, states and even localities have gotten into the sanctions game. In the 1980s a number of localities would not accept tenders from businesses either doing business with South Africa or investing there. In May 1997, the Washington Post reported that state economic sanctions were either operative or pending in California, Colorado, Texas, North Carolina, Massachusetts, Connecticut, and Rhode Island. Localities such as New York City, San Francisco, Chapel Hill, and Alameda Country were also active.6 "Some companies," it was reported "have pulled out of Burma in part because of local government sanctions."7
COSTS IMPOSED UPON TARGET STATES
Clearly, sanctions must impose significant damage if the policy goals are to be achieved. Economic effectiveness describes the degree of disruption created. The costs imposed may be classified, albeit somewhat arbitrarily, as direct, indirect, capital effects, and foregone potential.
Direct Costs
Direct costs are immediately and directly related to sanctions imposition. Rising transport expenses are an obvious example. Previously, Cuba’s imports came mainly from the United States, with the exception of oil, which was imported from Venezuela. New suppliers were far more distant, hence rising transport expenses. Another direct cost is the loss of traditional export revenues. Cuba lost a guaranteed sugar market and a lucrative tourist industry that catered to Americans. Tobacco earnings, formerly the chief source of Rhodesian foreign exchange, were largely eliminated, owing to the singular effectiveness of UN sanctions on this particular product. Iraq has obviously lost substantial oil revenues. Under the Arab boycott, Israel lost both its supply source for the Haifa oil ‘refinery and transit fees earned on Arab goods leaving from the Haifa port.
Adverse movements in the terms of trade are also direct costs. Risk premiums tend to be built into import prices, either due to the clandestine nature of "prohibited" trade, or fears of blacklisting, litigation, etc. A similar condition characterizes export prices. For example, because Rhodesia’s major export, tobacco, was easily identifiable, it was "forced to accept prices significantly below world market levels."8 Iraq today is experiencing a similar phenomenon, clandestinely selling oil in small quantities at distress prices.
Indirect Costs
Indirect costs result from the many domestic dislocations and slowing in the general economy that emanates from a disruption of normal external commerce. There are two drivers here: the normal foreign
trade multiplier deriving from export sales; and the critical linkage between imports of vital intermediate products (and raw materials) necessary for continuing domestic production processes. In 1966, for example, a Cuban official noted that "from 40 to 60 percent of the capacity of Cuban factories was idle because of a lack of parts or raw materials."9 And even when domestic substitutes can be produced, their technical adaptability is often poor. In Cuba, for example, in place of imported petroleum, sugar derivatives were often utilized for fuel. While vehicles and machinery were still often able to be used, they became subject to more frequent breakdown.
Negative financial repercussions are probably best classified as indirect costs. Inflationary pressures are always increased when there is a reduced ability to obtain imports. Financial markets also become disturbed and balance-of-payments problems, currency convertibility and a host of related difficulties appear or worsen. Transaction costs become disproportionate. Contemporary Iraq is a classic example of allthese problems.10
Capital Effects
Additionally, if some of the target state’s capital stock is imported, the capital infrastructure (or parts of it) may be rendered ineffective or useless if vital spare parts are denied. Further, if banned imports include intermediate products for which domestic (or foreign) substitutes are not available, some capital is likely to be idled, perhaps permanently. These capital effects are vividly illustrated in the first decade of the American boycott of Cuba. Virtually all of Cuba’s capital stock was produced in the United States, often uniquely designed forCuba’s special needs. Hence,0its inability to obtain American spare parts and maintenance equipment resulted in highly accelerated capital consumption. Cannibalization — the breaking down of equipment for its constituent parts — of factories, producer goods, and vehicles took place on a massive scale for at least a decade. This same practice has become widespread in contemporary Iraq. In short, successful denial of critical imported inputs is tantamount to pinpoint bombing. In this case, the capital stock is left intact but rendered economically useless. In the case of Cuba, the annual growth rate during the first decade probably fell by one to two points due to capital effects alone.11
Foregone Potential
A final cost category is forgone potential: certain expected future benefits, such as scale economies or future revenues become unattainable due to sanctions. For example, Cuba’s tourist industry, geared to Amencans, would likely have continued its steady growth; with the embargo, however, the industry disappeared. While the immediate loss of exchange earnings may be deemed a direct cost, future revenues, which would most certainly have grown, were lost. Consequently, forgone potential costs were incurred. The economic value, in terms of probable future receipts, without doubt exceeded the direct losses when sanctions were first imposed. Similarly, Rhodesia experienced significant foregone potential costs in its manufacturing sector. Cost reductions resulting from output expansions driven by sales to surrounding markets were left unrealized. Similarly, the Arab boycott of Israel successfully discouraged significant foreign investment inflows, another important foregone potential.
Vulnerability to Sanctions
Vulnerability to sanctions is a function of several factors, most of which, at least in theory, are reflected in the elasticity coefficients for imported items. In the Cuban case, with many intermediate product imports specially designed for unique Cuban usage, there were almost no alternate suppliers. Accordingly, low import elasticity demands meant highly effective sanctions. Few countries, however, were as technically tied to one supplier as Cuba was in the 1960s. As a rule, unilateral sanctions do not encounter very low import demand elasticities because there are many alternate suppliers. Importantly, elasticity coefficients are lower in the short run than over longer periods. Given sufficient time, adjustments can be made, domestic substitutes developed, or alternate suppliers found. Accordingly, if a target state can get "over the hump"— that initial period in which embargoes wreak the greatest havoc — the economic effectiveness of sanctions will progressively diminish. For Cuba, that period was about a decade;12 for Rhodesia it was about five years.
Sanctions vulnerability is a function of many factors — stage of economic development, economic and technical dependence on imports, degrees of diversification in terms of domestic production and trade partners, ability to contravene via clandestine trade and loose boycott enforcement, etc. Many of these are variables over which the boycotting state has little or no influence. Importantly. the major impediment to target state abilities to import has always been a lack of hard currency earnings. Hence, if export receipts can be substantially diminished, import volumes will fall and sanctions will hurt. On the other hand, if hard currency is available, external suppliers will always be forthcoming, although perhaps at higher prices. Additionally, there will be countermeasures by target state governments. Economic reorganization, adroit monetary-fiscal policies, promotion of rational import substitution,13 and efforts to stimulate saving and capital formation can greatly mitigate the effectiveness of sanctions. Finally, the incidence of sanctions may in part be shifted to third parties. Cuba found a white knight, the USSR, whose aid and trade deflected the embargo’s costs to the Soviet bloc. Similarly, some of the incidence of the Arab boycott against Israel was shifted to the U.S. taxpayer and world Jewry.
A CONSISTENTLY FAILING TOOL
"Sanctions have only rarely attained their declared goals."14 "The record demonstrates clearly that by themselves sanctions are seldom able to roll back military aggression, have limited ability to impair a targeted regime, and have never toppled a dictator."15 Because their economic effectiveness depends upon many variables over which the boycotting country has little control, it is not surprising that embargoes often impart only minor or temporary economic damage; hence the goals are not attained. Further, often the greatest cost is foregone potential, yet these are the least likely to apply pressure on a target state’s leadership. Finally, because the boycotting state’s sanctions program usually emanates from the complex interactions of domestic political and economic interest groups, "it would be nothing short of an amazing coincidence if the sanctions policy that emerged also happened to be the most damaging to the target"16 state. In short, the economic effectiveness of the sanctions design is often severely compromised or blunted.
But even when highly effective, as in the case of Cuba in the 1960s, contemporary Iraq, or Israeli sanctions against the Palestinian territories, the desired outcomes rarely prevail. Economic effectiveness is only a necessary condition for success — defined as attainment of the foreign policy goal — but hardly a sufficient condition. Economic harm must be translated through the target state’s political system into policy or regime changes. But to the degree that ruthless dictators prevail, or charismatic leaders engender popular support in spite of (or with the assistance of) sanctions, the political translation rarely occurs. Further, adroit target regimes can undertake actions to shift the domestic incidence of sanctions to groups without political clout. This is predictably done on a regular basis.
WHY INCREASED USE OF A FAILING INSTRUMENT?
If sanctions fail to deliver, why are they increasingly employed? There seem to be three basic reasons:
1. As public choice theory suggests, the recent growth in the use of sanctions reflects the general escalation of special-interest legislation that is inherent in democratic political processes. Almost always, domestic economic interests benefit from sanctions, either by removing foreign competitors or generating direct financial benefit. The Helms-Burton Act directed against Cuba in 1996 is a classic example of the latter.17
2. Sanctions are a "soft" option and therefore very appealing to domestic leaders. They are a positive response to pressures for "action" without requiring troop commitments, possible loss of life, or related military undertakings that would be certain to stir controversy. Importantly, they require no budgetary allocations. In this regard, they are a peculiar form of unfunded mandates.
3. They are a means of expressing disapproval and moral revulsion. Idealists who are justifiably repulsed by apartheid, Cotalitarianism, and repression are quick to embrace this soft option, generally unaware of and unaffected by the costs involved. Importantly, political "cheerleaders," either entrenched politicians or political aspirants, stand to benefit because their noble stand" with the righteous appeals to important constituencies, such as African-Americans, Cuban-Americans, etc. Unfortunately, there are often serious costs to the boycotting state, but these burdens rarely fall in the districts of the political cheerleaders, so here again sanctions appear as a soft option for gaining political approval.
COSTS IMPOSED ON AMERICAN BUSINESS
The costs imposed on American business may be grouped into three categories: direct, indirect, and foregone potential.
Direct Costs
Direct costs include the loss of current earnings when sales to a target state are terminated. Additionally, asset values may decline aixi lease revenues can fall. For example, because of Helms-Burton, an American company leasing aircraft was forced to get assurances from a Canadian airline that the airplane would not be operated in Cuba. resulting in the value of the lease falling by $1.5 million annually.18 Similarly, a number of American-owned properties in Panama had to be sold at distress prices. If import restrictions are part of the sanctions package, it is also likely that higher cost substitute suppliers, either domestic or foreign, will have to be utilized.
Indirect Costs
A myriad of possibilities are included as indirect costs, which may be labeled second-order effects. On the cost side of the ledger, lost sales lead to lower production runs, which often mean reduced learning curve advantages, loss of scale economies, or higher average fixed costs. Marketing and market development expenses tend to rise. For example, prior to establishing full relations with Vietnam, about 160 U.S. firms maintained a presence in Vietnam in anticipation of the normalization of U.S-Vietnamese relations.19 Foreign buyers may also require more sales time to convince them that the American supplier will be reliable (no sanctions), a liability most foreign companies do not bear. Included in this is greater
overhead and administrative expense as companies lobby in Washington to avoid or reduce trade interferences. Also, administrative costs and complications are magnified when this new variable — threat of possible sanctions — is injected into deliberations concerning foreign market development. The cost of capital may also rise because the denial of overseas markets can produce significant declines in rates of return. By lowering corporate profitability, it is possible that equity prices may fall and borrowing costs rise. Relatively smaller firms are most vulnerable in this regard.
On the demand side, there are several sources of indirect costs. In the absence of U.S. competition, foreign-based suppliers can charge higher prices in target states and generate increased returns. Such profics, in turn, can be "used to reduce prices and gain market share in countries where U.S. companies are permitted to do business."20 Additionally, American companies become less desirable partners for other foreign companies, thus depriving them of strategic cooperation advantages. Naturally, there are also negative multiplier effects that ripple through the domestic economy. Further, the presence of an American business overseas often generates positive spillovers for other U.S. products. For example, local merchants in proximity to an American installation often stock Cheerios, Lay’s Potato Chips, and other popular U.S. items. Local residents who might not otherwise be exposed to such goods thus get an opportunity to sample them and become habitual consumers. Sanctions, then, negate this positive impact. Finally, nations whose companies are threatened or harmed by secondary boycotts may retaliate against U.S. companies.
Foregone Potential
In the category of foregone potential are a number of likely scenarios. Future sales to the target state —replacement, follow-on, and servicing — are lost. Due to a possible unreliable supplier" label, third-party markets may seek alternate suppliers. Additionally, countries under sanctions may develop indigenous production capabilities that lead to export competition with U.S. suppliers. Turkey and Israel are examples of countries under arms embargoes that developed their own industries, with the latter undertaking vigorous export efforts.
Similar to the burdens imposed on target countries, corporate foregone potential costs are very often the most significant. In an analogous fashion, however, they also seem to be least effective in evoking changed policies. Direct costs, on the other hand, such as the closing of a production line, can and do attract the attention of political representatives in the production district.
Calculating the cost of sanctions to American companies is as difficult and tentative as estimates of the costs to target states. A variety of figures are provided to give some indication of general magnitudes involved:
- LeSeur suggests that the "Iran/Libya boycott law puts at risk, in the U.S. petroleum equipment sector alone, over S600 million in export sales and over 12,000 export-related jobs.
- Allied Signal reports that the latest sanctions against Iran are costing it "several million dollars a year."22
- One estimate of the Vietnam trade embargo was "as much as $1.5 billion a year...roughly equivalent to 28,650 jobs."23
- My own estimate of the Cuban embargo for 1995 is $2.08 billion in lost sales, or roughly 38,200 jobs. The cumulative cost of these sanctions since their inception is almost $90 billion in nominal dollars.24
- The value of lost exports in 1995 for all economic sanctions together (twenty-six target nations) has been estimated to be $15 to $19 billion. This equates to more than 200,000 relatively high-wage export sector jobs, depriving American families of almost $1 billion in higher wages.25
There are clearly differential impacts when businesses are categorized by size, particularly at the extremes. Large multinational organizations have very diversified operations and can afford to "absorb" the sanctions "tax" and still continue operations. Rates of return are normally only marginally impacted. If, however, a relatively small, export-oriented firm catering to only a few markets is suddenly denied one, a very large percentage of business may be lost, and major investments in establishing sales or operations in the target country may be completely destroyed. Such blows can be fatal.
OPTIONS FOR ACTION
Intermittent, isolated protests and lobbying by individual businesses, who are depicted as "greedy and unprincipled" by sanctions advocates, usually have little impact against the concentrated political power of those seeking to impose the sanctions. Accordingly, the business community collectively must join together in the hopes that a greater concentration of influence will speak louder. This effort, called USA Engage, has recently been launched.26
Because sanctions so rarely succeed, and because they impose many costs and often have perverse impacts, the first priority should be to drop sanctions completely from the foreign policy toolbox. If this is deemed too ambitious (as has apparently been concluded), the second option is to participate in sanctions only if they are very widely multilateral, which seems to be the prime goal of USA Engage. In this vein, multinational sanctions, for both foreign policy and business reasons, should be selective (a limited range
of commodities) rather than comprehensive. Universally applied selective sanctions, such as an arms embargo on Iraq, would limit the costs to American businesses and at the same time not engender all the perverse results (such as coalescing popular support behind a wicked leader, starving large numbers of innocent people, engendering antipathy for the United States, etc.) that sanctions so often generate.
Lastly, because sanctions are a national policy tool, there is no reason why the incidence of the sanctions "tax" should not fall on the citizen body as a whole rather than on selected segments of the population. In short, this unfunded mandate should be funded! While it is naive to believe that a perfect compensation scheme could be devised, it is certain that a reasonable program could be designed so that the incidence of such national efforts would not be fully borne by very selected portions of American society. Finally, such a scheme would greatly enhance the "transparency" of sanctions endeavors and undoubtedly result in a more sagacious application of this questionable foreign policy tool.
FOOTNOTES
1. National Association of Manufacturers, A Catalog of New U.S. Unilateral Economic Sanctions for Foreign Policy Purposes, 1993-1996. Washington, DC: National Association of Manufacturers, March, 1997, p v.
2. Ibid.
3. Ibid., p. 2.
4. A primary boycott exists when trade between two countries is severed or limited. With a secondary boycott, the boycotting state implements sanctions against foreign companies (or countries) that trade with the original target state, thus greatly enlarging the scope (and cbst) of sanctions. A tertiary boycott further widens the net, by levying sanctions against organizations dealing with companies subject to the secondary boycott. Secondary and tertiary boycotts have been most generally associated with the Arab League’s economic sanctions against Israel.
5. The United States has antiboycott legislation forbidding or limiting compliance with boycotts and mandating a reporting of boycott involvement. There are also tax penalties. See Department of the Treasury, The Operation and Effect of the International Boycott Provisions of the Internal Revenue Code, 7th report, Washington, DC: Internal Revenue Service, August, 1997.
6. Paul Blustein, "Thinking Globally, Punishing Locally," Washington Post, May 16, 1997, p. Gl.
7. lbid.
8. Donald L. Losman, "The Effects of Economic Boycotts," Lloyd’s Bank Review, October. 1972, p. 37.
9. Ibid., p. 32.
10. See, for example, Ann Reifenberg, "Dialing for Dinars: Iraqis Turn on Radio to Set Exchange Rate," Wall Street Journal, September 20, 1996, pp. lA & 7A.
11. See Donald L. Losman, International Economic Sanctions, Albuquerque: University of New Mexico Press, 1979, pp. 30-38 for an elaboration of these points.
12. That is why it is astounding to read in a November 994 report that there should be no relaxation of the Cuban boycott "just when it appears that the 32-year old embargo may be bearing fruit"! See John P. Sweeney, "Why the Cuban Trade Embargo Should be Maintained," Backgrounder. #1010, Heritage Foundation, Washington, DC, November 10, 1994, p. 1.
13. It is of interest to note that theoretically, if infant industry potential exists, the involuntary import protection that sanctions provide can activate the development of healthy, comparative-advantage based sectors that might not otherwise have been forthcoming. In practice, however, while there are many claims to this effect, there are only a few genuine examples.
14. "Makio Miyaga, Do Sanctions Work? New York: St. Martin’s Press, 1992, p. 206. See also Donald L. Losman, ‘Pain Without Gain: The Sanctions Saga," Mediterranean Quarterly, Winter, 1997, Volume 8, Number 1, pp. 36-59. For a more sanguine interpretation, see Gary C. Hufbauer, Jeifry Schott, and Karen A. Elliott, Economic Sanctions Reconsidered. 2nd edition, Washington, DC: Institute for International Economics, 1990. In more recent work Hufbauer has turned fairly negative (see Gary Hutbauer and Bruce E. Stokes, "The Benefits of Open Markets and the Costs of Trade Protection and Economic Sanctions," paper preseined at the American Council for Capital Formation’s symposium, Washington, DC, September 9, 1997.
15. George A. Lopez and David Cortright, "The Sanctions Era: An Alternative to Military Intervention," The Fletcher Forum, Summer/Fall, 1995, p. 70.
16. William H. Kaempfer and Anton D.Lowenberg, International Economic Sanctions: A Public Choice Perspective, Boulder: Westview Press, 1992, p. 163.
17. "See Louis F. Deslage, "The Great Cuban Embargo Scam," Washington Post, March 3, 1996, p. C-i.
18. National Association of Manufacturers, p. 2.
19. Council on Competitiveness, Economic Security. The Dollars and Sense of U.S. Foreign PoliO’, Washington, DC, February, 1994, p. 23.
20. Ken R. LeSeur, "Sanctions: An Ineffective Tool of Diplomacy," Houston Business Review, Fall, 1996, p. 67.
21. Ibid., p. 68.
22. Louis Uchitelle, ‘Who’s Punishing Whom?" New York Times, September 11, 1996, p. Dl.
23. Council on Competitiveness, p. 23.
24. The estimate was derived as follows: The U.S. share of Cuba’s imports during the 1949-58 period was 75.8 percent. This figure was applied to Cuban imports from the embargo’s inception through 1995, the raw data being taken from Director of Intelligence, Cuba: Handbook of Trade Statistics, 1995, Washington, DC: Central Intelligence Agency, November, 1995, and successive issues of the Statesman ‘s Yearbook (1962 onward). These estimates are most certainly conservative. The embargo was so damaging to Cuba’s economy that GDP levels were very retarded; hence import volumes have been far lower than would otherwise have been the case.
25. Gary Clyde Hufbauer, Kimberly Ann Elliott, Tess Cyrus, and Elizabeth Winston, U.S. Economic Sanctions: Their Impact on Trade, Jobs, Wages, Washington, DC: Institute for International Economics, April 16, 1997.
26. USA-Engage is a broad-based business coalition founded in early 1997 for the purpose of ending unilateral sanctions efforts.
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