Multilateral malaise – The war in Ukraine’s impact on trade policy

The flood of post-Ukraine sanctions signals shifting Western calculations but the aftermath risks lasting damage to world trade

The war in Ukraine will change the world in many ways. One change that deserves more attention is how the conflict is impacting trade policy and thus reshaping trade flows, creating opportunities and challenging long-held assumptions on how nations’ economic and strategic interests should align.

The evolving content of Western sanctions is tracked on our Sanctions Notes blog. Here we consider the legal problems these sanctions are creating and how that will likely shape future trade policy.

Sanctions on Russia – A new playbook emerges

Economic sanctions are traditionally considered coercive measures designed to bring about a change of behaviour. The point is not to punish but to bring about change. They are also normally designed to maximise economic pain of the target while minimising that on the parties imposing the measures.

For this reason, trade measures are traditionally designed to be temporary with built-in expiry dates and sanctioned assets are normally frozen, not confiscated. The motivation and design of the current Russia sanctions are more complex. The sanctions on energy products, for example, are being introduced gradually and appear to be intended as permanent measures. Also, there are moves to use sanctioned assets to further the aims of the sanctions – that is to move towards confiscation rather than freezing.

The strong retributive or moral element in these measures may lead to more harm to the sanctioning states being accepted than would otherwise be the case. Normally, commodities such as diamonds, precious metals or oil are not the subject of sanctions imposed by only some countries since such trade is easily diverted and the sanctions will mainly serve to enrich traders in other parts of the world. However, commodities are an important feature of Western sanctions on Russia and the logic seems to be that Western money should not flow to Russia (even if other money does).

Another feature of the current wave of sanctions is the prohibition of exports to Russia. The blocking of non-military exports usually features less in sanctions regimes than prohibitions on imports because they may hurt the sanctioning country more than the target. In contrast, the moral motivation for sanctions on Russia has led, for example, to the prohibition by the UK of the provision of a wide range of financial services to Russian individuals.

The result is that the sanctions regimes are constantly evolving and innovations not seen before are being introduced. Sanctions are always a relatively blunt instrument that causes collateral damage to innocent parties. One consequence of the innovation occurring now is that collateral damage is unpredictable and could be widespread. It is also likely to give rise to more litigation than in the case of past regimes.

The impact of counter-sanctions – A process of reinforcement

The measures targeting Russia are leading to counter-sanctions imposed by Russia on Western interests. The freezing of central bank assets has led to the requirement to pay for oil and gas imports from Russia in roubles, leading to the cutting of gas supplies to countries refusing to pay in Russian currency. The prohibition of certain other transactions by Western governments has led to the blocking of aircraft and vessels and the threatened taking over of business goodwill and intellectual property rights.

Sanctions and counter-sanctions are reinforcing each other. The West wants to cut energy imports from Russia and Russia responds by cutting energy supplies to certain countries. The West wants to cut Russia off from the financial system and Russia responds by resorting to measures that isolate it from the Western financial system.

Circumventing sanctions and secondary sanctions

Trade sanctions are most effective when universal. Unilateral measures can be avoided by trade diversion, especially with commodities and other fungible goods. For this reason, many sanctions regimes are applied extraterritorially, although there are often legal and practical limits to this.

The US was the most enthusiastic user of extraterritorial sanctions and this was facilitated by the US dollar’s dominance in international trade and the widespread presence of US companies throughout the world. The EU previously opposed this practice and has a blocking regulation that prohibits EU persons from complying with certain US sanctions. The EU even brought a World Trade Organization (WTO) case against the US to oppose the application to EU persons of the US Helms-Burton Act against Cuba.

However, the EU is now a convert to the need for sanctions to be applied extraterritorially. As trade diversion manifests, the EU will face the question of whether it should apply so-called secondary sanctions to countries or entities that too enthusiastically circumvent its sanctions.

The impact on trade agreements

Suspension of Russia’s MFN status and its impact on the WTO

Most Favoured Nation Treatment (MFN) is the foundation of the GATT/WTO system of promoting international trade and exceptions are limited and well-defined. There is no WTO mechanism for suspending or removing MFN status or even ejecting a member from the organisation. There are security exceptions allowing restrictive trade measures on both goods and services to be taken against a WTO member, notably “in time of war or other emergency in international relations”. A number of countries, including the G7 and EU, have suspended MFN treatment of Russia. This means they consider their restrictive measures on goods and services against Russia as justified by national security exceptions.

WTO members have long struggled with the limits to the national security exceptions, which are drafted in somewhat self-judging terms. Recent dispute settlement cases have shown that the constraints exist even if they are not severe. There must be a rational connection between the measure and the emergency. A delicate issue will arise once the war is over if restrictive measures are maintained against Russia to reduce dependence on imports from Russia or as punishment for its actions in Ukraine.

The granting of preferences to Ukraine

The main exception to MFN treatment in the WTO is the authorisation of trade preferences needed for the creation of a free trade area or a customs union. The EU and UK have free trade agreements with Ukraine but have now gone further and removed all duties and restrictions in trade with Ukraine. This obviously goes further than requirements to create a free trade area. The WTO MFN principle would therefore require this removal of duties and other trade restrictions be extended to all WTO members. The statement by the G7, the EU and others referred to above includes a suggestion that “actions in support of Ukraine” are also covered by their invocation of the national security exception.

The impact on other countries

Trade with other countries will also be impacted by the measures taken with respect to Russia and Ukraine. On one hand there will be opportunities for neutral states to fill gaps in sanctioned products and services no longer coming from Russia. There is also the possibility for countries that do not impose similar sanctions to purchase goods and possibly services from Russia at lower prices and correspondingly reduce purchases from elsewhere. This, however, risks being perceived as circumvention and that may lead to some restraint.

One concrete example of indirect impacts on third countries concerns the steel safeguards imposed by the EU and UK to guard against trade diversion following the US Section 232 measures. Here the EU has announced it will redistribute to other countries the quotas that can no longer be used by Russia because of the EU sanctions so as not to increase the protective effect of these measures. The UK is also redistributing the quotas it had attributed to Russia.

Overall impact on trade deals – Stoking unilateral action

Unforeseen events such as the invasion of Ukraine are not addressed in trade agreements and therefore autonomous or unilateral measures are more likely to be needed. Efforts are being made among like-minded Western countries to adopt measures that do not conflict with or undermine those of their allies. The measures remain autonomous, however, and there is no prospect of adoption by the United Nations Security Council because of Russia’s permanent membership and veto authority.

These policies are therefore providing further impetus to the move already apparent for some time in the US and EU to favour autonomous measures over those needing multilateral agreement.

The WTO is scheduled to hold its twice-delayed ministerial conference on 12-15 June, which it was hoped would make progress towards further agreement on subsidies. This is now in danger because the EU, UK and US in particular, would refuse to participate if Russia is allowed to speak.

Conclusion

Trade patterns are being severely disrupted by the war in Ukraine and the various sanction responses. While this is unsurprising, the real danger is that of lasting damage to the world trading system. The sanctions the West is imposing appear designed to last and lead to permanent Russian isolation. This may be intended as punishment and serve as an example to others; it may also signal belief that increased economic interdependence does not always lead to lasting peace as was once widely argued. On the contrary, economic interdependence can create obstacles to measures needed to preserve that peace. Such a consensus, were it to take hold, would only reinforce the recent unilateralist shift in trade policy and have profound consequences for global trade.

This article first appeared in our Competition Notes blog