The impact of the war in Ukraine on Trade Policy

The war in Ukraine will change the world in many ways. One change that deserves more attention is how it is impacting trade policy and thus changing trade flows and creating trade opportunities.

The evolving content of Western sanctions is tracked on our Sanctions Notes pages. In this note we will look at the legal problems that these sanctions are creating and how that may affect future trade policy.

Some features of the sanctions on Russia

Economic sanctions are traditionally considered to be coercive measures that are designed to bring about a change of behaviour. The point is not to punish but to change behaviour. They are also normally designed to maximise the economic pain on 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 seem to be intended to be permanent. 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 sanctions 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 prohibition of non-military exports usually features less in sanctions regimes than prohibitions on imports because they may hurt the sanctioning country more than the sanctioned country. The moral component of the 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 that is occurring now is that the collateral damage is unpredictable and could be widespread. It is likely to give rise to more litigation than in the case of past regimes.

The impact of counter-sanctions

The sanctions on 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 that refuse to pay in Roubles. 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 the energy supplies to certain countries itself. The West want to cut Russia off from the financial system and Russia responds by resorting to measures that isolate it from the Western financial system.

The circumvention of sanctions and secondary and tertiary sanctions

Trade sanctions are most effective where they are universal. Unilateral sanctions can be avoided by trade diversion, especially in the case of 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 United States was the most enthusiastic user of extraterritorial sanctions and this was facilitated by the use of the US dollar in international trade and the widespread presence of US companies through subsidiaries and licensing agreements throughout the world. In the past, the EU opposed this practice and has a blocking regulation that prohibits EU persons from complying with certain US sanctions. The EU even brought a WTO dispute settlement case against the US in order to oppose the application to EU persons of the US Helms-Burton Act against Cuba.

The EU is now a convert to the need for sanctions to be applied extraterritorially. As trade diversion manifests itself, the EU will be faced with the question of whether it should seek to apply so-called secondary sanctions to countries or entities that are too enthusiastically circumventing EU sanctions.

The impact on Trade agreements

• The 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 and exceptions are limited and well-defined. There is no WTO mechanism for suspending or removing MFN status or even for ejecting a member from the organisation. There are security exceptions that allow restrictive trade measures on both goods and services trade 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 the EU have announced that they have suspended MFN treatment of Russia. What they mean by this is that they consider the restrictive measures concerning goods and services that they are taking against Russia are justified by the national security exceptions.

WTO Members have long struggled with the limits to the national security exceptions, which is drafted to some extent in self-judging terms (measures that "it considers necessary"). As described in our Article on the National Security Exception, 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 and restrictive and discriminatory measures are maintained against Russia in order to reduce dependence on Russia or as punishment for actions in Ukraine or even as an example to others.

• The grant of preferences to Ukraine

The main exception to MFN treatment in the WTO is the authorisation of trade preferences necessary for the creation of a free trade area or a customs union. The EU and the UK have free trade agreements with Ukraine but have now gone further and have removed all duties and restrictions in trade with Ukraine. This obviously goes further than what was necessary for the creation of a free trade area since the additional preferences are not provided for in the agreements setting it up and are therefore not necessary for its creation. The WTO MFN principle would therefore require that this removal of duties and other 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 the one hand there will be opportunities for them to supply to the countries imposing sanctions the products and services that are 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 the UK to guard against trade diversion following the US Section 232 measures. Here the EU has announced that it will redistribute the quotas that can no longer be used by Russia as a result of the EU sanctions to other countries so as not to increase the protective effect of these safeguard measures on the EU. The UK is also redistributing the quotas that it had attributed to Russia.

• Overall effect on trade agreements

An unforeseen event such as the invasion of Ukraine is not something that is foreseen or regulated in trade agreements. It therefore leads to the adoption of autonomous or unilateral measures. Efforts are being made amongst 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 them being adopted by the United Nations Security Council because of Russia's permanent membership and veto authority.

These measures are therefore providing further impetus to the move that has been apparent for some time in the US and the EU to favour autonomous measures over those that require 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, the UK and the 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 sanctions regimes. While this is unsurprising, the real danger is that of lasting damage to the world trading system. The sanctions that the West is imposing on Russia seem to be designed to last and lead to the permanent isolation of Russia. This may be intended to be a punishment and to serve as an example to others; it may also be the consequence of a realisation that increased economic interdependence does not necessarily lead to lasting peace as was widely argued but can also create obstacles to the taking of measures necessary to try to preserve peace.