COSTS OF A NEW COLD WAR

COSTS OF A NEW

COLD WARThe U.S.-Russia

Confrontation

over Ukraine

Paul J. Saunders, Editor

COSTS OF A NEW COLD WAR: THE U.S. RUSSIA CONFRONTATION OVER

UKRAINE

Paul J. Saunders, Editor

September 2014

CENTER FOR THE NATIONAL INTEREST

The Center for the National Interest is a non-partisan public policy institution established by former President Richard Nixon in 1994. Its current programs focus on American national security, energy security and climate change, Iran’s nuclear program, maritime security, and U.S. relations with China, Japan, Europe, and Russia. The Center also publishes the bimonthly foreign affairs magazine The National Interest. The Center is supported by foundation, corporate and individual donors as well as by an endowment. Copyright 2014 Center for the National Interest. All Rights Reserved. Costs of a New Cold War: The U.S.-Russia Confrontation over Ukraine Paul J. Saunders, Editor Center for the National Interest 1025 Connecticut Avenue, NW, Suite 1200 Washington, DC 20036 Phone: (202) 887-1000 E-mail: [email protected] www.cftni.org

TABLE OF CONTENTS

OVERVIEW: TOWARD A NEW COLD WAR? By Paul J. Saunders RUSSIA’S ASYMMETRICAL RESPONSE: GLOBAL AIKIDO By Fyodor Lukyanov THE DANGERS OF A NEW CONTAINMENT POLICY FOR RUSSIA By Thomas Graham TARGETED SANCTIONS WITH AN UNCLEAR TARGET By Igor Yurgens RUSSIA, UKRAINE, AND U.S. ECONOMIC POLICY By Blake Marshall

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TOWARD A NEW COLD WAR?

BY PAUL J. SAUNDERS Relations between the United States and Russia have steadily deteriorated since the collapse of Viktor Yanukovych’s presidency and Russia’s subsequent annexation of Crimea and support for separatist rebels in eastern Ukraine. After just a few months, the ties between Washington and Moscow have unraveled remarkably rapidly, reaching a level of tension unprecedented since Russia’s independence in 1992. And the crisis continues to get worse—on an almost daily basis. This leads to two important questions. First, how bad can the U.S.-Russia relationship get? More significantly, what could be the consequences of this deterioration for U.S. vital interests? Relations between Washington and Moscow are arguably already worse than U.S.-Soviet/Russian relations at any time since 1986, when Ronald Reagan and Mikhail Gorbachev established the practice of wary but constructive cooperation that steadily improved during Reagan’s remaining years in office and throughout the George H.W. Bush administration. Moreover, mutual expectations between 1986 and 1992 were cautious yet positive, while today they are cynical and negative. How long will it take for both sides to begin acting and talking as if it were 1984 rather than 2014? The clock hands seem to be spinning backwards. U.S.-Russian and European-Russian differences over Ukraine are clearly driving this process, though the Ukraine crisis followed years of growing frustration on all sides. At the time of this writing, the United Nations estimates that the death toll in the ongoing fighting in eastern Ukraine has recently doubled within two weeks’ time, to over 2,600, with more than 6,000 wounded.1 Although Ukrainian government forces appeared increasingly successful on the battlefield during much of August, the separatists reversed this momentum at the end of the month, possibly with direct Russian assistance. Though a shaky cease-fire is now in place, new fighting would raise inevitable and appropriate questions about U.S. and NATO military aid to Ukraine’s government. Meanwhile, the United States and the European Union have announced further economic sanctions on Russia in an apparent effort to strengthen

1John Revill, “Civilian Death Toll in Ukraine Rising, U.N. Report,” The Wall Street Journal, August 29, 2014, http://online.wsj.com/articles/civilian-death-toll-in-ukraine-rising-u-n-report-says-1409299965

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Kiev’s weak hand in talks. For its part, Moscow has threatened a variety of retaliatory measures. President Vladimir Putin has also announced a major restructuring of Russia’s military-industrial complex—taking personal charge—and called for widespread modernization of Russia’s military.2 Even with talks underway between Ukraine’s government and rebels, the United States and Russia continue to escalate their actions and rhetoric. While it is too soon to predict the course or outcome of the negotiations, the rebels appear to be in a strong position (with Russia’s support) after Ukraine’s acceptance of a cease-fire in place. If the conflict resumes, the Kremlin need only avoid allowing Kiev to defeat the separatists; merely sustaining the insurgency will be sufficient to enable Russia to achieve its objective of forcing Ukraine’s government to provide greater autonomy to the Russian-speakers in the country’s eastern and southern regions. Already committed to expending $20 billion over the next five years to integrate Crimea3—which it seized largely intact—with Russia proper, Moscow is unlikely to seek annexation of a region devastated by civil war when it could instead consolidate its influence there while ensuring that financial responsibility for the territory and its residents remains with Kiev, Brussels, and Washington. This would produce further incremental expansion of Russian aid to the rebels (rather than a large-scale invasion) and could lead to a long and grinding conflict in Ukraine. At best, it could produce an enduring stalemate with daily civilian casualties and dangerous possibilities for new tragedies like the downing of Malaysian Airlines Flight 17. Unfortunately, it would be a mistake to assume that a Ukrainian defeat of rebel forces—which Moscow seems unwilling to permit—would obviate the escalation danger. If the so-called People’s Republics in Donetsk and Luhansk should collapse, a deeper crisis between the U.S. and Russia could well follow. Most immediately, how would the Kiev government treat defeated rebel leaders, soldiers, and sympathizers? Would Ukraine’s military and police protect Russian-speaking civilians in eastern Ukraine from the reprisals that are all-to-common after civil conflicts? What political conditions would Ukraine’s government impose – and how would Moscow react? More broadly, how would the United States react to a Ukrainian military victory? Would the Obama administration attempt to calm U.S.-Russian 2 “Meeting on drafting the 2016–2025 State Armament Programme,” http://eng.kremlin.ru/news/22930. 3 "Crimea, Sevastopol to Get 700 Billion Rubles for Development in Next 5 Years," ITAR-TASS News Agency, August 7, 2014, http://en.itar-tass.com/economy/743917.

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tensions and revoke American sanctions while Moscow still controls Crimea? Or would the administration continue to pressure Russia in an effort to return the Peninsula to Kiev’s control? After achieving victory, how would Ukraine’s government handle delicate post-conflict issues like de-mobilization, reconciliation, and reconstruction? How will citizens in eastern Ukraine react? And how would Russia react? How would Putin respond internationally and domestically to the humiliation of defeat? Conversely, if current negotiations produce an agreement on autonomy that looks like a defeat for Ukraine, how will the United States and NATO respond? Would Russia contribute economically to reconstruction in new autonomous regions in Donetsk and Luhansk? It would be much less expensive that taking full responsibility for the costs, as would be required if Russia annexed the territory, and could have strong symbolism. How would the West view this? Would it look like expanding Russian influence in Ukraine? This is another path to enduring confrontation. Since we cannot predict the future with certainty, it is impossible to answer these questions definitively. What is clear, however, is that without a comprehensive political settlement, there are many plausible paths to escalation and further crisis in U.S.-Russia relations. Some argue that this matters little because Russia lacks the capability to seriously threaten or harm vital U.S. national interests, and that American resolve could deter such efforts by imposing much greater costs on Moscow. Moreover, they argue, the high stakes in Ukraine justify any risks possibly entailed in directly and immediately confronting Russia. Conversely, some in Russia argue that America lacks the will to confront Moscow or that U.S. and Western action will do more damage to America and its allies than to Russia. The question of what is at stake for the United States in Ukraine—and the related one of what the Obama administration is willing to do about it—have been topics of considerable debate, and the answers will ultimately become clear as America’s political system translates this debate into action (or inaction) over time. The goal of this publication is to illustrate the costs that any further unraveling of the U.S.-Russian relationship may have for both Washington and Moscow in light of some of the policies that each government may pursue. The intent is not to make threats but to present reasonable or even likely policy pathways should Washington and Moscow settle on confrontation rather than the more challenging process of de-escalation and re-engagement.

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Hopefully this may encourage all sides to reduce tensions in order to limit damage to their own interests. These papers do not attempt to propose any particular solution to this extremely complex problem. This volume presents two American perspectives and two Russian ones on U.S. and Russian policy options in an environment of deteriorating relations. The two U.S. authors, Thomas Graham and Blake Marshall, outline America’s possible political/security and economic responses, respectively. The two Russian authors, Fyodor Lukyanov and Igor Yurgens, assess Russia’s potential policy responses, with the same division of labor. All four authors have extensive, multifaceted experience with the U.S.-Russia relationship. The overarching conclusion of the four papers is that both the U.S. and Russian governments are likely to believe that they possess acceptable policy options to not only confront one another but to impose significant costs on the other party if necessary. However, one foundation of this judgment on both sides is a failure to recognize the potential price that their own nation may pay in a direct conflict or (more likely) in a long-term adversarial relationship. On the U.S. side of this equation, Graham outlines a combination of changes in NATO basing and force posture, expanded missile defense deployments, new security cooperation with Russia’s post-Soviet neighbors, and efforts to restrict Russia’s access to defense and energy technologies, among other likely measures. Considering how Russia’s leaders have defined the country’s security over the last two decades—in speeches, interviews, and statements responding to events, as well as in formal doctrine and guidance to defense officials and diplomats—the security moves that Graham outlines could dramatically worsen Russia’s overall security environment. If NATO members simultaneously increase their defense spending and pursue greater military integration—strengthening NATO’s capabilities by eliminating duplication—Moscow would face a more powerful NATO. Meanwhile, while not without cost to the United States and especially to European countries, the harsh economic sanctions that Marshall describes could significantly damage the Russian economy. If America is able to help the European Union to reduce its energy imports from Russia, it would further increase the impact of sanctions. Gazprom may well be able to find other customers, but it would be costly and time-consuming to build new infrastructure—and the company might find it difficult to get customers willing to pay European-level prices (particularly if Gazprom’s prospective


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partners gain negotiating leverage due to Russia’s partial isolation). The global nature of the oil market would make it harder to deny revenue to Russia’s major oil exporters, but technology restrictions could cut into oil production over time. Though Marshall does not mention the option, the U.S. Congress could also impose sanctions on third countries, targeting firms that trade with Russian companies. Congress has taken this approach to sanctions against Iran in the past. Even with $500 billion in reserves, Russia could not indefinitely sustain its current government budgets under heavy economic pressure. Further, the potential that investors will begin to sense that Russia may be in trouble could produce high volatility and sharp drops in markets, whether for currency, debt, or stocks. From a Russian perspective, Lukyanov argues that Vladimir Putin will seek to use America’s size and power against it in a form of geopolitical judo. He argues that Putin may be reluctant to foment instability in countries like Afghanistan—where spillover could affect Russia. Instead, Putin will seek to rally governments troubled by U.S. conduct to form a coalition to press for an overhaul of global governance and institutions that would weaken American and Western dominance. Beijing would be a key player, he suggests, in addition to other large emerging economies and any other governments dissatisfied with the political, economic, or social/cultural consequences of globalization. Moscow could catalyze this process by developing and articulating a new ideology based on equality and justice among nations. Further, Lukyanov writes, it may be enough for the Kremlin to cease its cooperation with Washington in the security sphere, rather than actively opposing the United States. For example, he suggests, Putin saved America from another costly and unpredictable war in the Middle East (or from a humiliating retreat from President Obama’s “red line”) by facilitating an agreement on Syria’s chemical weapons. International expectations of the United States have grown to such an extent that they are both hard to fulfill and hard to ignore. Without Moscow’s help, America may face more and more embarrassment. Yurgens thoroughly assesses the challenges to Russia’s economy entailed in any extended confrontation, but adds that the longer the crisis continues, the more the influence of Russia’s “neoconservatives”—whom he defines as foreign policy hawks content with economic isolation from the West—will increase. Concurrently, the political constituency in Russia favoring economic

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engagement will suffer the most from Western sanctions and will lose influence, especially if the United States and the West refuse to offer any carrots to facilitate a settlement in Ukraine. As a result, Yurgens asserts, Moscow’s policy is likely to become less economically rational over time, as Russia’s economic integration with the United States and the EU assumes diminished importance in Russian politics and in Kremlin decision-making. In addition, Moscow will have to look harder for new markets and new lenders, he says. Notwithstanding its reluctance to become dependent upon China, he continues, Moscow will likely see this as “the lesser of two evils” if relations with the West remain strained. Yurgens also outlines existing proposals to reduce Russia’s economic ties to the West. Moscow’s options would include: moving dollar- and Euro-denominated assets out of NATO countries to neutral nations, returning state-owned property to Russia, halting exports of strategic metals and minerals, shifting trade to barter trade or settling transactions using non-Western currencies, taxing capital flight, establishing a domestic electronic payment system, and a number of other steps. Actions like these would of course have real impacts inside Russia, but would nonetheless impose costs on Western financial institutions. Although Yurgens does not address the risks of nationalization, Western firms would be ill-advised to ignore that possibility if an escalating military conflict prompts U.S. and European sanctions intended to cripple the Russian economy. One key point emerging from all four papers is that it is impossible to fully assess the consequences of an enduring U.S.-Russia confrontation without considering responses by other key actors, including the EU, NATO, major European governments, and China. American and Russian policy rests on certain assumptions about Europe and China that analysts should acknowledge. On the U.S. side, for example, likely U.S. security policies—reinforcing security ties to NATO allies, expanding missile defense, and increasing defense cooperation and military deployments along Russia’s frontiers—would require a generally unified Europe prepared to risk sustained confrontation. U.S. efforts to isolate Russia economically may actually require an even greater level of coordination with Europe (since its economic relationship with Russia is an order of magnitude larger than is America’s and Europe would shoulder most of the costs). Fully isolating Russia economically would also require cooperation from China. Conversely, given the huge military and economic disparities between the United States and Russia—much less those between the West as a whole and Russia—Moscow’s probable policy course of action depends upon rapidly


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expanding trade and investment ties with China and other emerging economies. Russia would also require sufficient dissension within NATO to prevent the most threatening Alliance moves—e.g., deployment of ground-based anti-missile interceptors in Central Europe, which Russian military leaders have said would undermine their ability to deter a nuclear attack. Without the former, Russia’s economy could face significant and lasting damage;; without the latter, Russia’s security environment could deteriorate sharply. A logical strategy for Moscow would be to continue its past efforts to court China while dividing Europe. Graham’s, Lukyanov’s, and Yurgens’ papers each address Russia’s relations with China and articulate prevailing perspectives in Washington and Moscow. In the United States, for example, Graham writes that closer energy cooperation with Beijing “is not without serious risk” for Russia, because Moscow would be in a relatively weak bargaining position. Nevertheless, Lukyanov argues, China may welcome and support Russian attempts at a global realignment that consolidates cooperation among governments opposed to Western concepts of world order and is combined with progressive social values. Indeed, although Beijing may be unwilling to lead such an effort itself, its tacit encouragement—and willingness to settle transactions in currencies other than the dollar or the Euro, among other measures—could have significant consequences over time. In Europe, Russia may find it more difficult to exploit internal differences there, particularly after the MH17 disaster, which appears to have unified and hardened public opinion and official policies. That said, even during the height of the Cold War, the Soviet Union was often able to find and exacerbate points of tension within NATO. Given its power and its distance from European Russia, the United States has historically been more willing to pursue confrontational policies than many of its allies. Moreover, the longer the current confrontation lasts, the more actual and potential differences within the West will emerge; it will not be easy to sustain consensus-based policies indefinitely, particularly when they have disparate impacts on individual nations. Of course, aggressive Russian policies can (and have) overcome this, at least for a time. What both Washington and Moscow would do well to recognize is that their relationship has entered unchartered territory. The U.S.-Russia relationship has returned to the 1980s in its temperature, but not in its management—contacts between officials are more limited, the informal rules and patterns of the Cold War have been forgotten, and the combination of globalization with the information revolution and changing norms and priorities (especially

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in the West) has made our bilateral relations harder to understand or predict. From this perspective, the late 1940s and early 1950s, a time when the two governments were just beginning to figure out how to deal with one another through a succession of trial-and-error experiments, may provide a better analogy. Even after over a decade into that process, the two sides came dangerously close to a war during the Cuban Missile Crisis. Today, Russia lacks the Soviet Union’s capabilities, whether in military, political, or economic terms. Nevertheless, it retains many of the USSR’s nuclear weapons, both strategic and tactical, and both Russian military doctrine and elite-level Russian politics assign continuing importance to nuclear weapons far beyond that offered by their American counterparts. This is an especially significant considering during times of crisis. Deescalating the conflict in Ukraine and working toward a political settlement will be extremely difficult. After all, a settlement is only a settlement if it is acceptable to all sides, and it is not yet clear that Ukrainian, Russian, American, and European interests intersect sufficiently to allow for such a solution. Nevertheless, the alternative—continued escalation with no apparent upward limit—is also very unattractive for everyone, and first and foremost for Ukraine. Absent a political solution, the United States should do whatever it takes to protect vital U.S. national interests in the current dispute with Russia over Ukraine and to defend U.S. allies. In doing so, however, American officials should consider carefully the potential costs of a long-term adversarial relationship with Moscow. Russia’s leaders will make their own decisions, but they would do their country a service by also evaluating the costs of a long-term tensions.

RUSSIA’S ASYMMETRICAL RESPONSE: GLOBAL AIKIDO

BY FYODOR LUKYANOV Forecasting global developments is the first and foremost task of professional policy analysts, whether they work for the government or for corporations, and for researchers, who attempt to study events from an academic perspective. But experience shows that such forecasting is not always precise, in part because those who conduct it are often influenced by prevailing stereotypes. Thus, a combination of rational evaluation and literary fantasy sometimes proves to be much more accurate than traditional, matter-of-fact analytical work. The Specter of the Future Let us imagine a not-so-distant future—the fall of 2017. A major international conference entitled “One-hundred Years after the October Revolution: Lessons for the 21st Century” is taking place in Moscow. The conference’s attendees include Chinese President Xi Jinping, Brazilian President Dilma Rousseff, Indian Prime Minister Narendra Modi, South African President Jacob Zuma, Iranian President Hassan Rouhani, and the leaders of many other Latin American, Asian, and African countries. Additional guests include prominent European politicians—not only those professing leftist and social-democratic views but also Eurosceptics—and representatives of non-governmental organizations, anti-globalization movements, etc. Russian President Vladimir Putin delivers a keynote address. Its focus is not on communist ideology or attempts to revive the Soviet economic and political model. Instead, its underlying message is that the Russian Revolution of October 1917 ushered in a new era in the history of mankind. It was a pivotal point that began a drive for equality and justice, and that rejected the power of a small group of countries, monarchs, and financial and industrial conglomerates over most of the world’s citizens. Although actual practice exposed the faults and blunders made when building “real socialism,” these mistakes did not undermine the international, historical importance of the event. In today’s new chapter, mankind should remember the energy for renewal and the aspirations to build a fairer and more democratic world that the 1917 Revolution unleashed. Now, at the beginning of the 21st century, the world is again undertaking this quest, having become tired of an

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international system dominated ideologically, politically, and economically by one power center that seeks to impose its development model on others, often by force. Everyone immediately recognizes the identity of this single power center. Today, this sounds like fantasy. Modern Russia was born in 1991, through the rejection of communism. Vladimir Putin is the direct heir to Mikhail Gorbachev, the politician who drove to dissolution the Soviet system created by the October Revolution. Russian life and economic practices are characterized by many of the typical features of early capitalism, and are much harsher than living and economic conditions in the United States or in Western Europe. Doing business in Russia – and living there – are sometimes extremely unfair, partly due to the country’s feudal form of government and partly due to this government’s inefficiency. Beyond this, Kremlin ideology is based on conservative, traditional values, at least as they are understood by the present Russian leadership. Although Russia’s foreign policy is based in part on opposition to the West, Russia is not engaged in an ideological confrontation like the one that secured the Soviet Union support from and robust diplomatic ties with many developing countries. However bizarre this vision may seem to Western readers, the logic of politics may push Russia to seek ways to expand its support in the world should confrontation with the West, and especially with the United States, deepen. If America and Europe respond to a possible political settlement in Ukraine by further increasing the pressure on Russia—to add to Ukraine’s negotiating leverage, or to try to go beyond stabilizing eastern Ukraine to return Crimea to Kiev’s control—that could still happen. And Moscow has many options for responding to American pressure, which is likely to grow in the years ahead almost regardless of immediate outcomes in Ukraine. But the situation is not symmetrical, and the United States objectively has more ways to influence Russia than vice versa. The “war of sanctions lists” that erupts from time to time between Russia and the United States is a vivid, albeit comical, example that shows the uselessness of the “eye for an eye” approach. In 2012, after the U.S. Congress passed the Magnitsky Act, Moscow responded by adopting a similar law and creating a list of American officials to whom it intended to deny entry to Russia. But it was hardly a match for Washington’s move. In fact, it’s difficult to imagine why American Senators or judges would consider it necessary to go to Russia; their Russian colleagues are far more likely to travel to the United States. Furthermore, the mutual freeze of assets looks like a joke. There is no proof that the officials from the so-called “Magnitsky

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list” or other such lists have assets in the U.S., but America’s “violators of the rights of Russian people” surely do not have any holdings in Russia. Clearly, however, Moscow will not sit idly and simply register new restrictions imposed by Washington—Russia’s retaliatory agricultural sanctions make this clear, as do Prime Minister Dmitry Medvedev’s threats to shut off access to Russian airspace for Western commercial airlines. Moscow understands that if relations continue to deteriorate further, the United States and its allies (many reluctantly and under pressure) may move over to informal but systemic measures intended to deter Russia and cut it off from Western financing and technology. In fact, widespread elite opinion in Russia holds that our relations with the United States have already assumed a state essentially reminiscent of the Cold War. Most believe this situation will most likely continue for several more years, and that it is not simply connected narrowly to the Ukrainian crisis. Washington regards Moscow as a force that inhibits what the United States considers to be the proper functioning of the international system. Therefore, this force must be curbed and prevented from questioning the order of things. Yet for Russia, the incorporation of Crimea became a red line beyond which there is no going back without risking political collapse. If the United States and the West also view Crimea as a red line, and continue heavy pressure on Russia even after a possible settlement in eastern Ukraine, it may be difficult to avoid a worsening long-term confrontation. Given these asymmetrical realities, Kremlin leaders understand that Russia should avoid getting involved in reciprocal responses modeled on the methods employed by the Soviet Union, which closely watched the balance of actions and reactions between both sides. Symbolically, Russia has always acted quite reciprocally. Suffice it to recall its response to incidents involving Russian citizens in other countries, such as when three Russian school kids, the children of Russian diplomats, were beaten up under unclear circumstances in Poland in 2007. Subsequently, three Poles were attacked in Moscow. Or recall that when Dutch police used force against a Russian deputy ambassador during a row over Russia’s detention of a Greenpeace ship in 2013, his counterpart was roughed up in Moscow. This list can be continued. However, Russia does no more than merely demonstrate its commitment to national prestige. Most understand that Russia lacks sufficient power to deliver an equivalent, reciprocal response to hostile U.S. moves. This means

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not only that its responses should be asymmetrical and “creative,” but also that they should be systemic and strategic. Above all, Russia should use objective global development trends that can benefit it, especially the rise of China and other emerging economies and the diffusion of economic power, while also exploiting U.S. weaknesses unrelated to Russian interests and activities but tied to America’s position as a global leader. When experts study Vladimir Putin’s political style, they often recall one of his sport hobbies: Oriental martial arts, specifically judo. While musing over Moscow’s responses to U.S. pressure, one is compelled to draw an analogy from Putin’s pastime;; namely, that one of the key skills in many martial arts (in judo and even more so in aikido) is the ability to first avoid a heavier opponent’s overpowering attacks and to then turn the opponent’s weight advantage against him by using momentum and inertia. These principles are likely to prevail in a potential Russian-American confrontation. Will Russia Seek an Eye for an Eye? But before one begins to study this confrontation from a martial arts perspective, one should consider several more likely and expectable Russian measures. They may not necessarily be taken, but the possibility that they will be cannot be dismissed. They are described quite well in an article written by Russian international relations expert Alexei Fenenko4 and published by the online edition of Russia Direct, and we may as well rely in our analysis on his conclusions. One way to take revenge upon America, Fenenko argues, would be to create problems for the Northern Distribution Network, which is critical for providing logistical support to U.S. troops in Afghanistan. Since the United States is in the crucial stage of its withdrawal from that country amid a disastrous situation in Iraq, intentional complication of this process could create serious problems for Washington. Denunciation of the agreements signed in 2008 and 2009 with NATO and a ban on land and air transit through Russia could also be a possibility. This would make the United States and its allies hurriedly look for alternative routes in the Caucasus and Kazakhstan, which would be costlier and longer, while transit through Pakistan would be fraught with serious security risks.

4 "Don't Tease the Bear: Russia's Retaliatory Sanctions Have Teeth," Alexey Fenenko, Russia Direct, April 3, 2014, available at http://www.russia-direct.org/content/dont-tease-bear-russias-retaliatory-sanctions-have-teeth


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Experts also mention Russia’s pressure on its Collective Security Treaty Organization (CSTO) allies to curtail their cooperation with the United States and NATO on Afghanistan. This is possible in principle, but some of Moscow’s partners may sabotage this effort to avoid putting all their eggs in Russia’s basket. Uzbekistan, which has officially quit the CSTO and is not Russia’s ally, would be least reliable. Another traditional area where Russia could make a U-turn and thus influence the United States is arms control and international nuclear security treaties, especially since practically all of them contain a clause allowing Russia to withdraw if its national security is endangered. In fact, when New START was under negotiation, some skeptical voices in Moscow questioned the need for new agreements with the United States. The treaty’s preamble, which links defensive and offensive strategic armaments, is interpreted in Russia as providing an indisputable right to repudiate all agreements if the United States proceeds with its missile defense plan. Since U.S. missile defense deployment is underway, it won’t be hard to find such justification in Russia. In March of this year, rumors emerged that Russia would renege on the agreement giving American inspectors access to its nuclear arsenals. This hasn’t happened yet, but limiting transparency measures is a natural possibility as bilateral relations are increasingly characterized by militaristic rhetoric. Some international treaties, particularly those signed by Presidents Mikhail Gorbachev and Boris Yeltsin, were never popular in the Russian strategic community. The wisdom of continuing to honor the 1987 INF Treaty and the Comprehensive Test Ban Treaty (CTBT), to which Russia acceded in 1996, are most often questioned. In a confrontation with the United States, Moscow could abandon them, especially since the CTBT has not been ratified by the United States or China and the INF Treaty is already producing fierce disagreements between Russia and America. Following through on Vladimir Putin’s recent indication that Russia could terminate the INF Treaty would quickly affect the course of events, most likely reviving Europe’s worries of the 1980s, when the Old World feared becoming a battlefield between the United States and the Soviet Union. At the time, Europe’s fears were two-fold: On one hand, Europeans urged America to strengthen Europe’s nuclear forces to deter the Soviets;; On the other hand, there were strong anti-war protest movements in Europe directed against America, which left-wing activists and sympathetic leftist

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politicians said was ready to sacrifice Europe to further its own superpower ambitions. Now, of course, the situation is different: Russia is not the Soviet Union, nor can it mobilize the broad European public for its benefit. At the same time, however, America’s popularity in Europe has plunged, especially after a series of U.S. scandals and failures in the world, ranging from mistreatment of prisoners in Iraq to electronic surveillance and spying. Another possibility that would annoy America would be Russia’s return to Cuba and restoration of the Russian radar station at Lourdes, which was closed by Vladimir Putin in 2001. This option was discussed in 2007, when Russia and the United States were at loggerheads over missile defense, but things did not go any further then. Today, this looks more probable, as Russia is generally bent on restoring relations with former Soviet allies. The closure of the radar station angered Cuba’s then-leader, Fidel Castro, and its present leadership will most likely welcome its reopening, especially since it will give the country an additional source of much needed revenue. After Putin’s visit to Cuba in July 2014, the Russian president publicly denounced rumors of a deal to reactivate the station and said that no agreement has been reached. Of course, this doesn’t exclude the possibility of reaching one later. Russia can also make things harder for the United States in the Middle East. Moscow’s firm and unyielding position on Syria in 2011-2014 has partly restored the Kremlin’s authority in the region, which was lost after the disintegration of the Soviet Union and Russia’s disinterest in the region during the 1990s. Many countries, including those historically relying on the United States but deeply disappointed by its ill-considered and inconsistent policies in the region, expect Russia to assume a more active position. With Iraq falling apart and the Syrian-Iraqi region turning into a battlefield for religious war, Russia can step up its support for traditional partners such as Bashar al-Assad, Iran, and pro-Iranian Shiites in Iraq. Lifting sanctions on Tehran if its nuclear talks end successfully would allow Moscow to resume full-scale arms sales, energy trade, and peaceful nuclear cooperation with Iran. However, frankly speaking, it’s hard to imagine what exciting and provocative steps Moscow could take now to create more problems for the United States in the Middle East, as the situation there is already highly chaotic – even by Middle Eastern standards.


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Fenenko comes to the conclusion in his article that unlike the Soviet Union, Russia can, as a last resort, take drastic measures to destabilize the global situation. He thinks that, in the Soviet Union,

the prevailing view was that global stability in itself is valuable, even at the cost of serious concessions. Now the situation has changed. Russia’s changed circumstances since the Soviet era is impelling Moscow to look at tougher retaliatory measures. The Soviet leadership felt more secure in its superpower status and could afford not to respond to provocation. The Russian leadership has no such safety margin.

However, it’s hard to agree with this conclusion. In fact, the Soviet Union did feel quite secure and never doubted its ability to control processes, since dramatic and dangerous confrontation always occurred within certain limits, written or unwritten. This enabled the Kremlin (and the White House) to do many things. For example, Moscow could afford to support and even foment regional conflicts, finance the “right” kind of extremist and terrorist organizations, test its strength in different parts of the world, and raise the degree of confrontation while firmly believing that de-escalation was quite possible, if necessary. Today, the Russian leadership thinks differently. Vladimir Putin has spoken often about the dangers of a chaotic, unpredictable, and uncontrollable world, a world of unforeseen consequences. Uncertainty about the results is the main deterrent to geopolitical troublemaking. The Russian leadership believes that the United States pursues an adventurist and irresponsible policy by getting engaged in different foreign campaigns and endeavors with unfathomable results. The growing uncontrollability of the international environment is seriously worrying the Kremlin, which is well aware of Russia’s vulnerabilities to instability. Thus the desire to improve Russia’s position by fishing in “murky waters” is not currently the underlying motive of the Russian leadership. Still, Russia views what is required for achieving stability differently than does the United States in some respects—as is obvious in Syria—and steps by Moscow to promote stability could instead look—in American eyes—like attempts to promote the opposite. Setting this aside, however, Russia’s actions are as a rule reactive and defensive in nature, even if they look offensive and aggressive. The incorporation of Crimea is not an exception to this, as it was driven primarily by the fear of having on its border either a completely uncontrolled and explosive state or an officially-avowed anti-Russian one.

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(Actually, both of these outcomes are still possible and an anti-Russian Ukraine seems increasingly likely.) Russia’s involvement, albeit quite reluctant, in the civil war in eastern Ukraine only bears out Moscow’s concerns that nothing can be predicted. Besides, we should remember one of Putin’s personal features: Being generally quite suspicious of the West in general and having no positive feelings about the United States in particular, he is very fastidious about the promises he makes. This explains why Russia has so far not even considered terminating its cooperation with Washington and NATO on Afghanistan, even though this would be a logical step now that relations have chilled. It is notable that even the most consistent opponents of the United States in the State Duma mentioned this possibility for the first time only on July 17 of this year, after the Obama administration imposed fairly tough sanctions on selected Russian banks and energy companies. Taking all of this into account, it would be hard to imagine Russia deliberately destabilizing the world order and becoming a global spoiler preoccupied with damaging the United States. However, Moscow can pursue a different strategy, one not destructive (destroying the existing world order) but instead constructive (building a new world order). The world may already be ripe for this, and Russia has some tools for doing this that it has not used yet. This brings us back to “martial arts” and Russia’s search for asymmetrical policy responses. Russia’s Asymmetrical Option: Global Aikido Many believe that the new Russian-American and Russian-Western antagonisms differ from Cold War-era tensions because of the absence of an ideological basis for the conflict. According to this view, the new confrontation is a classical geopolitical rivalry: America seeks to sideline Russia, while Russia naturally resists, biting back wherever possible. Hence the expectation is that Moscow will start “taking revenge” on the U.S. in the Middle East, East Asia, and elsewhere. However, as was mentioned above, Russia would pay a significant price in a struggle like this. Yet there are two other options that are complementary, rather than mutually exclusive. One involves avoidance of any further, and termination of all existing, assistance to the United States without direct conflict. The other option is ideologizing the confrontation under the banner of building a new and more just world order in place of the U.S.-centric one that is now under increasing strain.


17

Let’s first discuss avoidance of assistance. It is widely believed in Russia that the United States, which has voluntarily assumed the role of world leader, is overstrained and unable to cope with this task. In practical diplomatic terms, this means that without assistance from its partners, Washington is unable to control many difficult processes in the world simultaneously, especially as their number is growing. In the most important conflict areas—Iran, Syria, North Korea, Afghanistan, and now Ukraine—the U.S. needs the participation of other countries. Even Russia is an integral part of solutions to some of these issues and others, as Americans themselves admit. Or rather, without Russia, there may be no solutions that do not require excessive expenditure. At the same time, against the background of unending public political discussions, Russian and American diplomats cooperate in a businesslike manner on a wide range of issues, including Iran’s nuclear program, Syria’s chemical disarmament, coordination of an international response to North Korea’s behavior, the settlement of endless contradictions within the WTO framework, and responses to local conflicts in Africa. In many cases—such as the Iran, Syria and North Korea ones—Russia’s connections and capabilities significantly facilitate communication and enable progress or, at least, prevent regression. Numerous conflicts in Asia, which are bound to escalate, are an obvious area where Russian-American interaction might be useful. In some cases, Russia is viewed as a more neutral participant, considered acceptable to all sides, than is the U.S. or Europe (the post-Soviet space is an obvious exception to this, but here one can only note the ever-continuing “agreement to disagree”). According to many Russian diplomats, if Russia simply ceases to participate in all these processes and ends its cooperation, the U.S. will soon be faced with growing problems. In this case, America’s military-political and economic weight will play against it, since expectations are high, but most complex conflicts require political solutions based on a multilevel and subtle approach. Russia’s disengagement would make this more difficult. Last fall’s chemical weapons agreement on Syria is an elegant example of this. Without the Russian President’s contribution, the U.S. might have been involved in yet another military campaign in the Middle East, with unpredictable results. The alternative to either reaching a deal or going to war was that America would have backed away from its own “red line.” Judging by what is occurring in Iraq today, it is easy to guess who would have benefited from U.S. strikes against Bashar al-Assad’s troops: the Islamic State, which is now occupying much of Iraq, and which was also a significant

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component of the Syrian opposition. Obviously, Vladimir Putin pursued his own and Russia’s interests, and in doing so helped America to avoid taking unnecessary and dangerous political-military actions. Generally, the scale of U.S. involvement in world affairs and the expectations associated with it are so great that U.S. leadership has turned into a heavy yoke that cannot be cast off, but is also increasingly hard to carry. Several years ago, when Barack Obama was preparing to become president,5 the idea of global burden-sharing—that is, delegating to key regional states the powers of supporting U.S. partners—became extremely popular. This was seen as a substitute for the unilateral leadership of the preceding Bush administration. Now we can say that the result is the opposite: the United States once again has to rely mainly on itself, while potential regional supporters behave more and more independently. But while unilateral leadership was previously a conscious choice, now it is the only possible option. Passive behavior—meaning not only that Russia will not use its capabilities against the United States, but also that it will not use them at all—would be quite in line with the philosophy of many martial arts, including dodging blows and benefiting from the rival’s mistakes.6 Russia would not apply this tactic in the post-Soviet space, where it plays sports like Thai boxing or even ultimate fighting, but in the rest of the world, where Russia has few if any vital interests. The second option is to take advantage of America’s setbacks in global governance and of the shortcomings in the global economic architecture. The Ukraine crisis has an important aspect that not everyone has been able to perceive: in a bid to punish Russia, the United States has used its power as a regulator of the world economic system as a weapon. By threatening to withhold the “keys” to globalization, it prompted its opponents to reclassify anti-Americanism into a conceptually much broader phenomenon: anti-globalism or, rather, alter-globalism; that is, moving beyond the current design of the global economy in favor of some other system. The White House’s decision to impose sanctions against the Russian officials it sees as being closest to Vladimir Putin led to sanctions being imposed against four Russian commercial banks. The payment systems Visa and 5 See, for example, Charles Kupchan and Adam Mount, “The Autonomy Rule,” Democracy Journal No. 12 (Spring 2009), available at http://www.democracyjournal.org/12/6680.php. 6 See Ivan Safranchuk, “Traveling in Different Boats,” Russia in Global Affairs No. 4 (October – December 2008), available at http://eng.globalaffairs.ru/number/n_11888.


19

MasterCard complied with the sanctions and blocked credit card services to these banks, which caused problems for the banks and fueled long-discussed plans to establish a national payment system in Russia. Also, Russia’s Ministry of Finance tightened rules for the two credit card companies, demanding that they make a huge security deposit as protection against force majeure. The possible outcome of the conflict is unclear; the credit card companies are threatening to leave the Russian market, but in the context of this discussion, this is not the most important consideration. Denying banks access to international transactions is a powerful lever, but demonstrating who the master in our shared global home is has a downside. U.S. world leadership is based on the conceptual premise that it not only ensures prosperity for all but that it is also just—it is not someone’s subjective will that decides everything; instead, the laws of the free market are supposedly decisive. Excluding Russian banks from payment systems, limiting the use of software produced by major IT companies, or shutting Russia out of the SWIFT system of international banking payments, a measure that was earlier taken against Iran, demonstrate an indisputable fact: one power has dominant influence and uses it for political purposes. As long as such measures were used against countries like Iran, not to mention odious governments like Gadhafi’s in Libya, they did not have such a strong effect. But when such pressure is put on one of the most important and influential countries in the world, it means that no one can feel safe. It also means that, in a heated conflict with the United States, global rules can be changed and directed to work against any target Washington desires. This stimulates new trends—the fragmentation of the global economy and society, the creation of zones of preferential trade rules and national or regional payment systems, and hedging against non-economic methods of global competition. American efforts to establish the Transatlantic Trade and Investment Partnership (TTIP) and the Trans-Pacific Partnership (TPP) trade zones actually undermine the WTO’s principle of universal rules for world trade. The rapidly strengthening partnership between Russia and China suggests that in response to U.S.-centric economic zones, they may try to compete with their own major projects—Russia’s Eurasian Economic Union and China’s Silk Road Economic Belt. Coordinating Russia’s and China’s interests in order to facilitate cooperation between these two entities will be difficult, yet hardly more so than is reaching an agreement between the U.S. and the EU on new trade rules.

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Russian Prime Minister Dmitry Medvedev and Minister of Economic Development Alexei Ulyukayev have both already promised to challenge U.S. sanctions in the WTO as unfair competition. If filed, this suit could take several years to be investigated, but it will support the key goal of demonstrating how the U.S. undermines its own principles for political purposes. After the end of the Cold War, the world saw little real institutional redesign. Some global governance institutions survived from the previous era, and some others, which formerly provided economic and financial services to the West, extended their operation to the rest of the world. At the rhetorical level, they came to reflect universal interests, but in practice there were continuous charges that these institutions remained instruments of Western control and dominance. The campaign of sanctions against Russia provides additional support for this view: for example, the European Bank for Reconstruction and Development, which in theory is an institution operating outside of politics, is being used by major shareholders to apply pressure on Russia. I repeat, such methods of pressure were used in the past as well. But they never were used against such a powerful state. The key issues are not military power nor energy levers, but are instead ideology and the ability to produce a universal narrative. Vladimir Putin has already begun to focus on this, as was clear in his recent remarks at the 2014 BRICS Summit in Brazil. The world as a whole is growing increasingly tired of the lack of alternatives to the U.S.-centric order. Not everyone likes the Western model of social order and political behavior, yet no one offers any viable alternative. Meanwhile, the complete domination by the United States in world affairs causes growing resentment and rejection of America, even among U.S. allies. Previous attempts to offer alternatives failed either because the countries that made them did not have enough international clout, or because of their scandalous leaders, like the late Hugo Chavez. Unlike these countries, Russia still has much of the strategic mindset of the USSR, which aspired to be a systemic alternative to the West. This factor manifested itself last year in the Middle East, where many expected that Russia would convert its successful Syria policy into the role that the Soviet Union had played in the region—namely, as a second patron to whom one could defect from the United States. There were, and could be, no such plans last year. Now the situation is changing—and Russia may be at least ready to assume this role.


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Acting as a serious troublemaker (Moscow did cross a red line in Crimea), Russia cannot continue to operate within the same global paradigm, wherein the West has an indisputable advantage. To strengthen its position, Moscow will have to oppose America ideologically and must formulate a different vision of the world order. Emphasizing conservatism will not be enough—this is good only for discussions within Western culture. A united “right-left” opposition is needed, in which the conservative defense of national identity would be combined with the Third World’s anti-globalist rhetoric about the injustice of the current system. No other country but Russia can bring about such an opposition. China values the opportunities provided by globalization, although it is not happy about everything. In addition, it is not good at advancing global-scale ideas—this has long been America’s forte. By virtue of its cultural identity, China’s ideological influence can only spread within the Chinese cultural area. On the other hand, Beijing can tacitly support such an initiative; after all, it hardly misses any opportunity to remind the West that the time of its hegemony has passed. Also, China understands that Russia’s conflict with the West has only postponed a global rivalry between China and the United States, which may unfold and intensify in a few years, probably by 2020. The dispute between Russia and the West has hardly erased Sino-U.S. tensions. That is why Russian-Chinese cooperation may become one of Russia’s most consistent responses to increasing pressure from the United States. At the global level, new Russian-Chinese cooperation is likely to spur systemic efforts by the two countries—albeit very cautious at first—to erode the global domination of institutions and practices of the Washington Consensus. A gradual weakening of the U.S. dollar in trade settlements among members of the SCO and the BRICS and the development and mutual recognition of national payment systems by them, the establishment by the BRICS of their own development bank,7 and the creation by Russia and China of an international rating agency to compete with the Big Three—Moody’s, Fitch, and Standard & Poor’s8—could be the first signs of a restructuring of the global economy.

7 Leonid Grigoriev and Alexandra Morozkina, "Different Economies, Similar Problems," Russia in Global Affairs, June 30, 2013, available at http://eng.globalaffairs.ru/number/Different-Economies-Similar-Problems-16051 8 "Siluanov: Russia and China Will Establish a Joint Rating Agency," Vedomosti, June 3, 2014, available at http://www.vedomosti.ru/finance/news/27301271/siluanov-rossiya-i-kitaj-sozdadut-sovmestnoe-rejtingovoe (In Russian).

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In early June, Russian Minister of Finance Anton Siluanov said at the fifth Financial Dialogue between Russia and China in Beijing that the two countries had agreed to establish a joint international rating agency. Earlier, the Chinese Dagong rating agency had announced plans to create a joint venture with American and Russian partners to organize an independent global rating group. The structure is to be called Universal Credit Rating Group. The partners will be Egan Jones Ratings of the United States and RusRating of Russia. The Russian parliament adopted a law on the establishment of a national payment system almost immediately after the banks Rossiya, SMP, and others were hit with U.S. sanctions. Potential international partners include China’s UnionPay, Japan’s JCB, as well as VISA and MasterCard. Brazil and Argentina may also participate in the project. Russia’s post-Crimea turn towards China may have another unexpected effect with serious consequences: the “nationalization” of the Internet. In addition to the two countries’ close positions on the role of the Internet Corporation for Assigned Names and Numbers (ICANN) and on Internet governance (the need to delegate the governance functions from a private U.S. company to international institutions), the Russian government’s determination to establish a Russian analog of the Great Firewall of China can be a kind of revenge of the Westphalian order on the World Wide Web. As noted by Russian researcher Dmitry Yefremenko, “the famous principle cuius regio eius religio (‘Whose realm, his religion’) in the middle of the 2010s can be reformulated as ‘Whose server, his Internet’.” The most likely outcome of this conflict will be the acceleration of a process that has long been spoken of in Russia: a departure from the U.S. dollar as the dominant currency in international trade transactions. Russian presidential advisor Sergei Glazyev has long insisted on such measures and has even proposed not using the dollar at all. Now this probability is discussed by Russian businesspeople.9 As a model, they look to Indian-Iranian transactions, whereby India pays for Iranian oil in rupees. Iran maintains a rupee account with UCO Bank in Kolkata, from where Indian exporters are paid against their shipments of various goods. Russia also had experience with such interaction in Soviet times. The Council for Mutual Economic Assistance, the economic wing of the Warsaw Pact, practiced trade in non-convertible currencies on a mutual offset basis. Another model, clearing, was used between the Soviet Union and Finland, for example. The

9 "Russian Companies Prepare to Pay for Trade in Renminbi," Jack Farchy and Kathrin Hille, Financial Times, June 8, 2014, available at http://www.ft.com/intl/cms/s/0/9f686816-ed51-11e3-abf3-00144feabdc0.html#axzz3A79iXllB


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May 2014 Russia-China gas deal, which contemplates $400 billion in gas supplies over the next 30 years, allows for some renminbi–ruble payments. Russian-Chinese rapprochement may also have a purely political regional effect—a marked strengthening of the Shanghai Cooperation Organization (SCO). The SCO is already the most representative and influential organization in Central Eurasia. Against a backdrop of ongoing geopolitical changes, it can increase its symbolic capital even further. Until recently, China had continuously delayed admitting India and Pakistan to the SCO. But now, according to Russian diplomats, Beijing is ready to take a more flexible approach because of its growing rivalry with the United States in East Asia. An enlarged SCO (including India, Pakistan, and also possibly Mongolia) could become a serious and highly diversified organization with unique capabilities in a critically important region. If the current negotiations on the Iranian nuclear program succeed and the UN Security Council lifts its sanctions against Tehran, Iran could become a full member as well (it now has observer status). The SCO Charter prohibits countries under international sanctions from enjoying full membership. Moscow will not be able to retain a monopoly on rule-setting in such a large organization involving such powerful countries. Actually, Russia does not have a monopoly now—China outweighs Russia economically, and if the SCO’s present composition does not change, there will be little room for balancing. But if the SCO admits India, Pakistan, and Iran, the diplomatic process within the organization will become more complicated but will also allow for more potential “coalitions.” In addition, the overall clout of the organization in the world will multiply. Back in 2005, the SCO called on the U.S. to clearly define a timeline for its presence in Central Asia. Now, the organization’s aversion to the U.S. presence in the region has only increased. Of course, Moscow will also take into account the growing tension between Washington and the latter’s European allies. Many of these allies have resisted strengthening of sanctions against Russia, because those measures will badly affect EU economies. Sanctions have already generated visible rift inside the EU, where businesspeople and even some in the political establishment complain that Washington has totally disregarded European interests while struggling to punish Russia, rather than attempting to resolve the crisis in Ukraine. This comes on top of fury in Germany about comprehensive spying by the U.S. that might have a long-term impact on transatlantic relations. Russia will not be afraid to use these sentiments to advance its interests.

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* * *

Over the 15 years of Vladimir Putin's rule, we have learned his political style well enough. Firstly, he never responds immediately and usually takes a break to consider matters; he has strategic patience. Secondly, he does not like to break promises, even if they were given to his opponents. Thirdly, he has a comprehensive view of the world, and he understands the world system and its various interrelationships. Combined with a tactical flair and fast adaptation to changes, this helps him to do without an action strategy, which hardly exists in practice. “As long as Russia is not subject to systemic sanctions, which could bring an artificial limit to our economy's access to dollars...then I don't think Russia will take any steps in order to bring about artificial de-dollarization," the Financial Times quoted Andrei Belousov, economic adviser to Mr. Putin, as saying.10 Yet one cannot rule out the possibility for exacerbation of the crisis in relations with the United States. If a real confrontation begins, Russia will seek to use objective weaknesses of the world leader. If Moscow sides with advocates of a revision of the current international system, which it has never supported before, this may significantly change the global balance of power. Russia may pool its capabilities with those of China—not in the military sphere, as only fringe Russian politicians propose, but in their approaches to global governance. As masters of judo teach, it is better to not rely on one’s own strength but to instead use your opponent’s strength against him. Formulating an alternative approach to global governance when disappointment over the present leader’s approaches is increasing is consistent with this teaching. Russia can become a catalyst of this process, which has already begun. This does not guarantee an immediate effect, but it could be quite successful over time.

10 "Russian Companies Prepare to Pay for Trade in Renminbi," Farchy and Hille, Financial Times, Op. Cit.

THE DANGERS OF A NEW CONTAINMENT POLICY FOR RUSSIA

BY THOMAS GRAHAM

The Ukraine crisis has ushered in a new era in U.S.-Russian relations. To be sure, relations had been deteriorating for some time—at least since fall 2011, when Putin announced his decision to return to the Kremlin. Stark differences between both countries over Syria and broader developments in the Arab world, Moscow's offer of asylum to NSA-leaker Edward Snowden, and Putin’s vehement accusations of U.S. interference in Russia's domestic affairs—thereby justifying a crackdown on internal dissent—have all stressed U.S.-Russian relations to the breaking point. The glimmer of hope offered by the agreement to work together to eliminate Syria's chemical weapons was quickly extinguished last fall by fundamental differences over the situation in the Ukraine. But it was Moscow's reaction to the ouster of President Yanukovych in Ukraine—its annexation of Crimea and the destabilization of southeastern Ukraine, done with a combination of audacity and skill—that finally jolted the American political establishment into viewing Russia as a significant threat. That Russia was prepared to flout the rules of Europe's post-Cold War order to assert its interests was not particularly surprising. After all, it had already done that in the Georgian War in 2008. But no one had anticipated that Russia would act in Crimea with such exquisite skill and leave the United States appearing flat-footed, lacking an adequate response. That set Ukraine apart from Georgia. Obama's reset is now dead. Previous failed resets were followed in short order by new attempts. Indeed, U.S.-Russian relations since the end of the Cold War have been marked by a recurring cycle of great expectations followed by deep disappointments. But this time is different. Today's estrangement runs deeper than it has during any time since the Gorbachev years. No influential forces in either Washington or Moscow are calling for improved relations; rather, political leaders and the media in both countries are actively vilifying the other side. Most bilateral contacts have been totally severed. Looking forward, both sides increasingly see each other as long-term adversaries. Unlike in the past, no new reset is just over the horizon simply awaiting a new American president.

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In the absent of significant hope for constructive relations, the American political establishment has reached back to the recent past, to the Cold War era, for guidance. The talk is of an updated containment policy.11 At the beginning of the crisis in early March, President Obama warned the Russians that if they did not move to deescalate the situation in Ukraine, the United States was "examining a whole series of steps—economic, diplomatic—that will isolate Russia and will have a negative impact on Russia’s economy and its status in the world."12 As the crisis worsened, the administration began to make good on that threat by sharply reducing bilateral contacts with Russia, levying targeted sanctions against individuals and entities considered either responsible for Russia's actions in Ukraine or to be financially close to Putin, and trying to rally European allies behind its policy. At the end of May, Obama claimed success.

Our ability to shape world opinion helped isolate Russia right away. Because of American leadership, the world immediately condemned Russian actions; Europe and the G7 joined us to impose sanctions; NATO reinforced our commitment to Eastern European allies; the IMF is helping to stabilize Ukraine’s economy; OSCE monitors brought the eyes of the world to unstable parts of Ukraine.13

With those and similar remarks, Obama may not have explicitly adopted a policy of containment, but the logic of his administration's actions points in that direction. The administration continues to threaten Russia with further sanctions should Moscow not act to deescalate the crisis, but it provides no clear indication of what Russia must do for the sanctions to be lifted. It speaks as if it intends to treat Russia as a long-term adversary (or for at least as long as Putin remains in power), while limiting cooperation—as in the Cold War—to those areas it judges critical to American security and which necessitate working with Russia (e.g., implementation of the new START

11 See "Summary of North American Chapter" in Paula Dobriansky, Andrzej Olechowski, Yukio Satoh, and Igor Yurgens, Engaging Russia: A Return to Containment?, The Trilateral Commission 2013/2014 Task Force Report, May 15, 2014, pp. 12-20, which leans heavily towards containment as the appropriate U.S. Russia policy. 12 See "Remarks by President Obama and Prime Minister Netanyahu before Bilateral Meeting," March 3, 2014, available at http://m.whitehouse.gov/the-press-office/2014/03/03/remarks-president-obama-and-prime-minister-netanyahu-bilateral-meeting. 13 See Remarks of President Barack Obama, Graduation Ceremony, West Point, New York, May 28, 2014, available at http://www.whitehouse.gov/the-press-office/2014/05/28/remarks-president-barack-obama-graduation-ceremony-west-point-new-york.

The Dangers of a New Containment Policy for Russia

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treaty and retaining access to the International Space Station). Moreover, its tendency to look at Russia and the Ukraine crisis solely through the prism of security in Europe—the Cold War's central battlefield—lends its Russia policy a Cold-War aura, even if Obama insists we are not witnessing a return to that era.14 There are good reasons for skepticism that the United States can contain Russia as effectively today as it once did the Soviet Union. Today's world is radically different from the Cold War's bipolar world of existential struggle between two diametrically opposed views of man, society, and the state, between two world systems with few points of contact. Now, in contrast, we live in an increasingly multipolar, globalized world in which traditional geopolitical competition is overlaid by a set of global challenges, the management of which requires collective action. Russia, among the world's largest economies, is moreover increasingly integrated into the global economy, having abandoned the Soviet quest for autarky, which is now considered unworkable. Under those circumstances, the developed world will not defer to the United States, as it generally did during the Cold War, and the major emerging powers are unlikely to give the U.S. much heed. Notwithstanding closer U.S.-European Union alignment and greater European unity after Ukraine’s rebel forces apparently accidentally shot down Malaysian Airlines Flight 17, the travails in forging transatlantic unity on tough sanctions against Russia and the refusal of China, India, and Brazil to condemn Russia's annexation of Crimea foretell the challenges ahead. If the current cease-fire in Ukraine holds and the parties begin to seek a political settlement, these challenges will grow.

* * *

The challenges, however, are not likely to dissuade the American political establishment from considering—nor the Administration from implementing—ever-harsher measures to tame a resurgent Russia, even if actual containment is infeasible. The prevailing view is that the United States, as a matter of principle and national interest, must push back vigorously against a Russia that challenges the principles of the American-led world order and that more often than not seeks to constrain American action on a range of functional and geopolitical matters.

14 Ibid.

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The world-order challenge is hardly new. Even under Yeltsin, the Kremlin never truly accepted American leadership. Initially it aspired to be an equal with the United States in managing the global agenda, however impossible an ambition that might have been given the gaping asymmetry in power and fortune between the two countries then. Later, it actively promoted a multipolar world, working with China and India, in particular, to create a counterbalance to the West. All along it vehemently opposed NATO expansion. Moreover, while it might have declared support for democratic and free-market principles, it upheld a traditional view of national sovereignty and rejected humanitarian intervention; witness the stiff opposition to NATO's military operation against Serbia for its actions in Kosovo in 1999. The United States evinced little concern, however, for Yeltsin's Russia was mired in a profound socioeconomic and political crisis and lacked the capability for effective resistance. That changed under Putin. The remarkable and largely unanticipated recovery that took place on his watch gave Russia the resources and confidence to pursue more assertive policies against what it saw as the United States’ hegemonic designs. Throughout his first two presidential terms, Putin sought to constrain the United States in three ways: He championed the UN Security Council as the sole authority for legitimating the use of force (other than in self-defense) and sought to bring key issues to the Council, where Russia could use its veto to thwart or shape American initiatives; He built coalitions designed to limit America's room for maneuver, taking the lead in creating the BRICS in order to lessen Western domination of global economic management and joining China in the Shanghai Cooperation Organization to constrain the United States in Central Asia; And he sought to build a partnership with the United States based on binding agreements that would limit American options and make it more predictable in Moscow's eyes. Russia did not stray from that three-pronged approach during the Medvedev interlude, even if Medvedev himself presented a more pleasant face to Washington. With his return to the Kremlin in May 2012, Putin took his opposition to the U.S.-led world order a step further, adding a moral dimension. He began to attack the West's growing decadence in rejecting "the Christian values that formed the foundations of Western civilization," including traditional sexual norms. While some Russian figures have advanced Eurasian values against European ones, Putin, more exactly speaking, has defended traditional European values against the West's post-modern interpretation of them, with an eye to bolstering his support among the deeply conservative Russian


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population, more traditional societies abroad, and even conservative segments of the West.15 The final, and most recent, challenge comes with Russia's seizure of Crimea, a clear violation of a fundamental principle of world order. Putin raised further alarms when he declared that Russia would "always defend the interests of [ethnic Russians and Russian-speakers in Ukraine] by political, diplomatic, and legal means."16 Although he limited the scope of his remarks to Ukraine, they were understandably read by Russia's immediate neighbors, all of which have sizable populations of ethnic Russians and Russian-speakers, as an implicit threat. Moreover, a generalized right to defend the interests of one's ethnic and cultural community would threaten havoc in a world, including Europe, where most states are in fact multiethnic. This broad-based challenge to the U.S.-led global order alone would have provided sufficient reason for the American political establishment to deal more severely with Russia. But the Ukraine crisis has also cast a harsher light on U.S.-Russian interaction on other functional and geopolitical issues. On none of these issues, save those concerning the former Soviet space, are American and Russian positions diametrically or irreconcilably opposed. Instead, different understandings of the nature of international problems, goals, and tactics complicate U.S.-Russian diplomacy and compel the United States to pursue less robust policies than those it would otherwise prefer. Iran offers an apt illustration of this. For the past decade, Russia has prevented the UN Security Council from endorsing the crippling sanctions the United States has advocated, because Russia has no interest in excessively harming a country that has largely respected its interests; because it sees preventing Iran from obtaining nuclear weapons as less of a priority than does the U.S.; and because it rejects Washington’s pursuit of regime change in Tehran. Analogous divergences in outlook and approach obtain on most of the high-profile international issues of the past ten to fifteen years, including on Syria and Iraq in the broader Middle East, and on North Korea in East Asia, as well as on non-proliferation and counterterrorism. Whatever cooperation there has been has occurred within a competitive framework.

15 See Putin's remarks at the Valdai International Discussion Club, September 19, 2013, from which the quoted material is drawn, available at http://news.kremlin.ru/transcripts/19243. 16 See "Obrashcheniye Prezidenta Rossiyskoy Federatsii," March 18, 2014, available at http://news.kremlin.ru/transcripts/20603.

http://news/

http://kremlin.ru/transcripts/19243

http://news.kremlin.ru/transcripts/20603

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This competition is most intense in the former Soviet space, which Russia sees as a zone of "privileged interest," as a critical buffer against neighboring great powers. Since the breakup of the Soviet Union, Russia has created various institutions designed to maintain its influence there, beginning with the Commonwealth of Independent States. The most ambitious to date is Putin's Eurasian Union, which he hopes will eventually include all the former Soviet states with the possible exception of the Baltic States. The United States has, however, made a special point of refusing to recognize any country's claimed sphere of interest. Yet it has pursued policies in the former Soviet space aimed in practice, if not in word, at limiting the Russian presence there, which is why Washington has refused to recognize or deal with any of the regional institutions Russia has sponsored, with the exception of the Shanghai Cooperation Organization. That is the unspoken goal behind NATO expansion. Ukraine today is only the most visible—and dangerous—example of a more general U.S.-Russian rivalry.

* * *

It is against this comprehensive and enduring threat (in Washington’s view) that the U.S. will now elaborate a new Russia policy. The initial decisions will of course be taken against the background of the Ukraine crisis. But even if Russia works diligently for a political resolution that respects Ukraine's sovereignty and territorial integrity, Washington will continue to seek ways to punish, constrain, and weaken Russia, now seen as an adversary. Should the U.S.-Russia relationship further deteriorate, the United States will likely pursue the following goals: • Short-term: Exacting a cost from Russia for its actions in Ukraine, deterring

further aggressive Russian actions, and persuading Moscow to support a political resolution acceptable to what the United States considers to be the legitimate Ukrainian government under President Poroshenko

• Medium-term: Degrading Russian capabilities and reducing its options for

expanding its sway in the former Soviet space and projecting its influence abroad, particularly into Europe

• Long-term: Exacerbating internal tensions in Russia in the hope that this will

lead to the mellowing of the current regime, or its overthrow


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The United States, alone and together with its various allies and partners, has already taken a number of steps in pursuit of these goals. They include imposing targeted sanctions against a limited number of Russian officials, and on other individuals and commercial entities considered financially close to Putin, as well as on a number of Russian defense firms; placing restrictions on new financing to Russia’s largest banks and energy companies; instituting stricter limits on the export of certain technologies to Russia; putting limitations on Russian access to certain U.S. facilities involved in developing cutting-edge technologies;17 taking steps to reassure vulnerable NATO member countries of the alliance's commitment to Article 5 collective defense guarantees;18 and exclusion of Russian from certain international organizations and mechanisms, such as the G8, now for all practical purposes the G7. Meanwhile, the United States and its allies are threatening further sanctions. So far, these steps have not noticeably affected Russia's policy toward Ukraine, including its support for separatist forces in eastern Ukraine and its integration of Crimea into the Russian political and socioeconomic system; on the contrary, Moscow has escalated its involvement in Ukraine as the United States and the EU have increased pressure on Russia. And they are unlikely to have much impact in the short run, because Moscow considers Ukraine to be a vital interest and is prepared to bear a heavy price to ensure that it does not move into the Western orbit. The more dangerous prospect for Moscow, however, is the longer-term implications for Russia's economic well-being of the American policies already in place and the still harsher steps the United States might take to harm Russia and its position in the world. Another paper will focus on the economic steps the United States can take and on the challenges taking these steps will present to Russia. The focus here will be on security, energy, and related policy.

* * *

In the security realm, the United States has several options. The first, and the most obvious, is further refocusing NATO on the emerging Russian threat.

17 See United States Department of State, "Ukraine and Russia Sanctions,” at http://m.state.gov/mc62304.htm. 18 See “Remarks by President Obama to the People of Estonia,” September 3, 2014, www.whitehouse.gov/the-press-office/2014/09/03/remarks-president-obama-people-estonia.

http://m.state.gov/mc62304.htm

http://www.whitehouse.gov/the-press-office/2014/09/03/remarks-president-obama-people-estonia

http://www.whitehouse.gov/the-press-office/2014/09/03/remarks-president-obama-people-estonia

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In a sense, the Ukraine crisis came as a god-send, with the alliance in the beginning stages of rethinking its mission as its involvement in Afghanistan draws to an end. Secretary General Rasmussen has called it a "game-changer" that compels NATO to reconsider an assumption that has guided defense planning for the past twenty years—namely, that Russia does not pose an imminent security threat.19 The NATO Summit in Wales illustrates how Washington will pursue this objective. With the energetic support of East European allies, the United States pressed alliance members at the summit to finally make good on their earlier commitments to spend at least 2 percent of their GDP on defense, to build up their conventional capabilities with new and more advanced equipment, and to integrate their capabilities more thoroughly. NATO’s summit communique particularly stressed the first two points.20 Poland and the Baltic states at a minimum will insist on more robust contingency planning and exercises for their region, and NATO could enhance its naval presence in the Black Sea. At the extreme, the United States could decide to establish a permanent military presence in East-Central Europe on the grounds that the security environment has changed in parlous ways unforeseen in 1997, thereby effectively abrogating NATO's pledge in the NATO-Russian Founding Act of 1997 to not permanently station "substantial combat forces" in that region.21 While straining to remain within the Founding Act’s boundaries, NATO moved in this direction at the Wales Summit, when its members agreed to “continuous air, land, and maritime presence and meaningful military activity in the eastern part of the Alliance, both on a rotational basis.”22 Secondly, and related to first option, as many commentators are already urging, the United States could reconsider it plans for missile defense in Europe. In 2009, the Obama administration abandoned its predecessor's plans to build missile defense sites in the Poland and the Czech Republic in favor of a different architecture, termed the European Phased Adaptive Approach. Although the administration argued then that it made the change based on a reassessment of the Iranian threat, the initial response from

19 See NATO Secretary General Rasmussen's monthly press conference, May 19, 2014, available at http://www.nato.int/cps/en/natolive/opinions_109980.htm. 20 “Wales Summit Declaration,” www.nato.int/cps/en/natohq/official_texts_112964.htm. 21 The text of the Act is available at http://www.nato.int/cps/en/natolive/official_texts_25468.htm. 22 See the Wales Summit Declaration.

http://www.nato.int/cps/en/natolive/opinions_109980.htm

http://www.nato.int/cps/en/natohq/official_texts_112964.htm

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Moscow was positive. (Moscow's position turned negative after it analyzed more fully the capabilities of the new system.) The administration could now decide to build a more robust and capable system in Europe. And it could do that even if the ongoing P5+1 negotiation with Iran lead to a deal on its nuclear program; conceptually, missile defense was intended to defend against a broader range of threats than those from Iran and North Korea, the countries of immediate concern.23 As part of that effort, the United States could locate more facilities in East-Central European states, including, at the extreme and most provocative, in the Ukraine. Along with the facilities would come at least a small permanent contingent of American military personnel, which would reassure the host governments of the United States' commitment to their defense. Thirdly, the United States could further bolster its bilateral defense cooperation with former Soviet states, especially Azerbaijan, Georgia, Moldova and Ukraine. There will be some pressure for the administration to press for NATO membership action plans for Ukraine and Georgia, although that remains a non-starter, given German attitudes, in particular, and given the situations on the ground in both countries. Nevertheless, the United States, alone or in cooperation with some allies, could help enhance the capabilities of these and other former Soviet states though programs similar to the train and equip program the Bush administration conducted with Georgia. Closer intelligence cooperation—especially on the Russian threat—could also be part of the package. After the NATO Summit, the White House issued a fact sheet describing some steps in this direction. Two military exercises involving Ukraine—one on Ukrainian territory—are planned for September.24 And should the cease-fire break down and Russia go so far as to invade Ukraine to defend ethic Russians and Russian-speakers, as Putin has threatened and more nationalist elements of the Russian elite desire, the United States—along with its allies—would almost certainly encourage Ukraine to resist. They would also begin to provide the equipment—non-lethal and lethal—and intelligence support with which to do so, with the goal of raising the prospects of a repeat of the Soviet experience in Afghanistan.

23 See the Missile Defense Agency's discussion of the threat, at http://www.mda.mil/system/threat.html. 24 “FACT SHEET: NATO and U.S. Efforts in Support of NATO Partners, Including Ukraine, Moldova, and Georgia,” www.whitehouse.gov/the-press-office/2014/09/05/fact-sheet-nato-and-us-efforts-support-nato-partners-including-ukraine-m.

http://www.mda.mil/system/threat.html

http://www.whitehouse.gov/the-press-office/2014/09/05/fact-sheet-nato-and-us-efforts-support-nato-partners-including-ukraine-m

http://www.whitehouse.gov/the-press-office/2014/09/05/fact-sheet-nato-and-us-efforts-support-nato-partners-including-ukraine-m

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Finally, the United States could impose ever stricter controls on technology exports to Russia and press its allies to do the same in order to retard the modernization of Russia's defense sector, which continues to face formidable problems and obstacles to growth. Its domestic machine-tool industry can no longer produce modern, advanced tools and is compelled to rely on foreign sources, while the military has turned to imports—such as Israeli unmanned aerial vehicles (UAVs) and the French Mistral amphibious assault vessel—for items which it cannot obtain domestically.25 France’s recent decision to withhold delivery of the first Mistral—the Vladivostok—reflects strong U.S. and NATO pressure to limit arms sales to Russia that could grow in the future. The United States will portray all of these steps as defensive, intended to reassure allies and to deter Russian aggression. Moscow, however, will see them as elements of a burgeoning strategic threat. European security, which for the past generation has been a more or less cooperative endeavor in dealing with challenges that emanate largely from outside Europe (WMD proliferation and international terrorism, for example) and pursuing arms control and other confidence-building measures to ease tensions, will once again become a competition in maintaining an appropriate military balance between Europe and Russia in and around Europe. The danger for Russia is that it will believe it is in an arms race, in which it starts at a significant disadvantage: Its military is no match for NATO, whose members spend over ten-times more than does Russia on defense and possess superior technical capabilities,26 and who maintain that superiority while spending less on defense as a share of GDP than does Russia. It is a race that Russia will be no better placed to win than was the Soviet Union during the Cold War.

* * *

In the field of energy, the United States also has at least three major options for pursuing two goals: diminishing Russian leverage in European markets (Russia supplies 45 and 33 percent of the EU's gas and oil imports, respectively, and about one-quarter of its gas resources overall27), and 25 See the International Institute for Strategic Studies, The Military Balance 2013 (London: Routledge, 2013), pp. 207-8. 26 See Slobodan Lekic, "Despite Cuts, NATO Still Accounts for Most of the World's Military Spending," Stars and Stripes, February 25, 2014. European NATO members spend more than three times more than Russia does. 27 See the European Commission on EU-Russia energy relations at http://ec.europa.eu/energy/international/bilateral_cooperation/russia/russia_en.htm.

http://ec.europa.eu/energy/international/bilateral_cooperation/russia/russia_en.htm


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undermining Russia's federal budget (oil and gas account for over half of revenues, with oil contributing 7-8 times more than does gas28). Firstly, as many commentators have already suggested, the United States could take advantage of the accelerating production of shale gas and tight oil to export significant volumes into global markets. That in itself would put downward pressure on prices to Russia's disadvantage. The implications for European markets are less straightforward. The overwhelming share of LNG now goes to Asian markets, where prices are higher and the infrastructure is better developed.29 As a result, the United States—and the EU—would have to put in place significant incentives to persuade private companies to export to Europe. Secondly, the United States could work toward the normalization of relations with Iran—a development that becomes more practicable as a deal on Iran's nuclear program approaches and both countries face the threat of the growing power of the militant Islamic State terrorists in Iraq. Normalization would open up the possibility of exports of Iranian gas into European markets. That would pose much more of a threat to Russia's market position. Not only does Iran hold the world's second-largest reserves of natural gas, but its gas would be exported by pipelines into the very markets that Russia now dominates in East-Central Europe. As part of this effort, the United States and the EU would need to work together to expand plans for the Southern Corridor, now being built primarily to compete with Russia's South Stream project. Thirdly, as with the defense sector, the United States could also put in place further sanctions and restrictions on technology exports that would retard the development of Russia's energy sector, expanding those imposed so far. As the old fields that were first developed during the Soviet period are depleted, Russia will have to move into geologically and climatically more challenging regions—offshore in the Arctic and onshore in East Siberia and in the Far East—to maintain adequate production levels. It does not, however, possess the technology or managerial skill to develop those Dependence varies greatly by country. The most vulnerable are the Baltic states, which rely entirely on Russia for their gas. Germany gets over 35 percent of its gas from Russia. See "Conscious Uncoupling," The Economist, April 5, 2014, available at http://ec.europa.eu/energy/international/bilateral_cooperation/russia/russia_en.htm. 28 Putin said earlier this year that oil accounts for $191-194 billion in revenue, and that gas constitutes $28 billion. See PBK, April 17, 2014, available at http://www.rbc.ru/rbcfreenews/20140417140241.shtml. 29 See "Conscious Uncoupling."

http://ec.europa.eu/energy/international/bilateral_cooperation/russia/russia_en.htm

http://www.rbc.ru/rbcfreenews/20140417140241.shtml

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resources on its own, and the only place it can get them is in the West. That is the primary reason why Russia's energy giants, Rosneft and Gazprom, have partnered with Western majors, such as ExxonMobil, Shell, and Total, on projects in Russia. To be sure, none of those three measures would have a significant and immediate impact on Russia's energy position. It would, for example, take a few years and billions of dollars in investment to build the infrastructure for the export of liquefied natural gas from the United States. But over the medium to long term, those steps would have the desired effect of squeezing Russia on both the demand and supply side, reducing Russia's presence in European markets, and putting pressure on its budget revenues. Russia will be challenged to formulate an effective response. Aware of the vulnerabilities, Putin has for some time promoted the diversification of Russia's energy export markets, with special emphasis upon China. Indeed, as the Ukraine crisis intensified in May, he traveled to China as if to demonstrate that Russia had alternatives. There he made a special point of heralding progress toward the formation of a "Sino-Russian energy alliance," which he said would be a critical element of energy security throughout the Asia-Pacific region. The showpiece of the alliance is the 30-year, $400-billion gas contract signed by Gazprom and China National Petroleum Corporation. Under its terms, Gazprom will, beginning in 2018, gradually build up to annually exporting 38 billion cubic meters of gas (roughly one-quarter of the amount it now sends to Europe30). The project will entail building a tremendous amount of infrastructure, creating, as Putin put it, "the biggest construction project in the world, without any exaggeration."31 A decision by the United States to move vigorously against Russia's energy sector entails serious risks. With reduced possibilities in Europe, less upside for domestic production, and the absence of the West as operator or investor in regions of prospective growth, Russia would find itself in a much weaker bargaining positions vis-à-vis China. The Chinese have a well-earned reputation for being tough negotiators, and they are not about to make concessions simply to curry Russia's favor. (There is already considerable speculation that, to close the gas deal, Russia made concessions on the

30 See U.S. Energy Information Administration, Natural Gas Weekly (for the week ending May 28, 2014), May 29, 2014. 31 See Putin's remarks at the St. Petersburg International Economic Forum, May 23, 2014. See also Alexei Anishchuk, "As Putin Looks East, China and Russia Sign $400-billion Gas Deal," Reuters, May 21, 2014.


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issue—price—that had been holding talks up for a decade, which Gazprom said was a "commercial secret,"32 presumably to conceal the scale of its concessions.) Russia will likely find itself at a great disadvantage not only in energy negotiations, but also across the board. The long-term danger is that Russia, or at least its East Siberian and Far Eastern provinces, will become a raw materials appendage of China.

* * *

Measures taken in the security and energy realms threaten to have the most devastating impact on Russia in the medium to long term. Additionally, there are less dramatic steps the United States could take to erode Russian power and influence. Frustrated by Russian obstructionism, it could, for instance, actively seek, along with its European allies, ways to circumvent the UN Security Council in ways that reflect little regard for Russia's interests, especially in regions where it enjoys a preponderance of force, such as in the Balkans in the 1990s. Similarly, it could work to limit Russian influence in other international and regional organizations, from the OSCE to the IMF and the WTO. And it could erode Russia's development prospects by encouraging greater brain drain by adopting more welcoming visa and immigration regulations. Creative minds will imagine further measures the U.S. could take in this area. The point is that the United States has a broad range of options to counter what it sees as a resurgent Russian threat. None of the options is cost-free, and the administration will not decide on any of them lightly, given the public mood against an activist U.S. foreign policy and America’s other priorities, including the Obama administration’s expanding military action against the Islamic State. And there are downsides that few of the most ardent proponents of containment have considered, including, ironically, the weakening of Russia to such an extent that it could no longer govern its own territory effectively or serve as an effective element in creating a global equilibrium. Nevertheless, it would be a mistake for Moscow to discount the possibility of a more concerted and assertive anti-Russian American policy. In the past few months, the mood in the United States has turned on Russia. That turn came

32 See, for example, "The Politics Behind Russia-China's Gas Deal,” Channel NewsAsia, June 1, 2014, available at http://www.channelnewsasia.com/news/world/the-politics-behind/1131860.html.

http://www.channelnewsasia.com/news/world/the-politics-behind/1131860.html

http://www.channelnewsasia.com/news/world/the-politics-behind/1131860.html

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not as a consequence of a single act or a specific crisis, but rather as the result of a long period of frustration in dealing with Russia and of skepticism that it approached relations in good faith—much the way the Russian mood about the United States has turned over the past decade. Meanwhile, the situation in Ukraine and elsewhere along the Russia periphery remains unsettled. There are ample opportunities for unanticipated events that could cause all sides to overreact. Moscow might believe the United States is mired in disarray and self-doubt, but it should remember that the American political establishment, despite Russia's recent assertive policy, continues to consider Russia to be in decline with a one-dimensional—and vulnerable—economy based principally on oil and gas. Rightly or wrongly, the Washington foreign policy establishment believes Russia will eventually succumb to American pressure. In such circumstances, as it develops its own policy, Moscow should never forget that the United States still retains considerable potential to do harm to Russia. That does not mean Washington is seeking confrontation. It is not, especially given the other challenges it is facing around the globe. Thus, even if tension will likely remain high for some time whatever the outcome in Ukraine, Russia still has an opportunity to avoid a determined U.S. effort at containment.

TARGETED SANCTIONS WITH AN UNCLEAR TARGET

By Igor Yurgens Russia’s relations with the West entered a new and less-than-happy chapter earlier this year. U.S. and European economic sanctions are the defining and consistent feature of this new chapter, though Russia’s actual and potential responses are becoming increasingly important. So far, Russia’s “internal diseases” have harmed it much more than Western sanctions. Likewise, the sanctions do not undermine the stability of the Russian political regime. On the contrary, the “personal” sanctions contribute to the Putin-driven soft nationalization of the elites, and the state can more than make up for financial losses sustained by certain individuals and companies. For the elements of Russian society already dissatisfied with the Russian government, such sanctions are a “bonus” of sorts that adds to their satisfaction over the Crimea annexation—Russia gets Crimea and despised elites are punished too. Nevertheless, new sanctions on Russia’s financial, energy, and defense sectors in July and September will have growing costs for key companies and the overall economy over time. Moscow’s retaliatory ban on certain Western agricultural imports shows that Russia is ready to engage in a tit-for-tat economic conflict—even though Russian officials recognize the economic asymmetries between their country and the West. Most importantly, beginning a new chapter is not the same as ending one—and it by no means preordains the final pages of the book. Perhaps ironically, the harder the West tries to isolate Russia, the more Western actions will strengthen forces inside the country that welcome isolation. This will make it increasingly difficult to find necessary cooperative solutions to current differences, and it is likely to increase costs on all sides. Russia’s Economy To start, it is necessary to understand the nature of the present-day Russian economy. In 2013, Russia posted 1.3% growth, the worst performance over President Vladimir Putin’s fifteen years in power except in 2009, when Russia faced the effects of the global financial crisis. As most are aware, Russia’s economy depends on commodity exports, which account for more than half

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of the nation’s fiscal revenues. This has created an institutional environment featuring excessive regulations, pervasive corruption, rent-seeking, and exploitation of administrative barriers. The Russian government addresses economic problems through micromanagement; this is known inside Russia as “manual control”—direct personal intervention by the President or other top leaders. Small- and medium-sized enterprises occupy an insignificant and precarious position in the economy, where high administrative barriers limit their growth. Private property rights lack adequate protection. Against this background, a tide of social challenges is rising on a national scale. One is the threat of depopulation. Russia’s Ministry of Economic Development expects Russia’s able-bodied population to decline by at least 8-9% by 2020. Labor’s poor geographic mobility exacerbates the labor shortage problem. Most experts comment on the poor quality of and diminished access to health and education; the growth of geographic inequality in terms of development standards and quality of life; and depletion of the nation’s natural capital. Despite sustained high oil and gas prices, the Russian economy has effectively been stagnant. GDP growth has consistently declined in recent years, from 4.3% in 2011, to 3.4% in 2012 and to 1.3% in 2013. For quite some time, numerous sources (including Russian officials) have been projecting, with some concern, that the economy could soon experience a recession. In recent years, inflation has fluctuated in the 6.1-6.6% range. Though tight monetary policies pursued by the Ministry of Finance and the Central Bank have admittedly been fairly successful, promoting quality growth requires keeping inflation below 3%. Finally, efforts to open up the country for adequate investment have failed. Russia has seen pre-crisis capital inflows ebb away as capital instead fled. In 2010, capital outflows stood at $33.6 billion, with $80.5 billion in 2011, $56.8 billion in 2012, $59.7 billion in 2013, and $75 billion in the first half of 2014. Western Economic Sanctions Currently, the IMF expects Russia to grow at 0.2% in 2014, while the OECD expects a growth rate of 0.5%. The European Bank for Reconstruction and Development (EBRD) assumes zero growth, while the Russian Ministry of Economic Development offers a number of scenarios: 0.5% growth if the Ukrainian situation turns out favorably, or a decline of 0.2% to 0.3% in the worst-case scenario.

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As for the sanctions, the Economic Development Ministry believes that Russia has sufficient reserves to make up for the resulting losses in the short term. Top Russian officials believe this too. Still, over the longer term, economic officials recognize and acknowledge that strong sanctions could destabilize the fiscal system and constrain technological modernization, due to restrictions on technology imports, investment, and application of best practices. In March, Moody's, Standard & Poor's, and Fitch revised Russia’s ratings because “elevated geopolitical risks and prospective sanctions … might reduce potential investments, increase capital flight, and further weaken the already declining economic performance.” Moody's put the long-term ratings of Russia’s public debt on a downgrade watch list. Standard & Poor's revised its outlook for Russia’s sovereign ratings from stable to negative, and Fitch similarly revised its outlook for long-term default ratings of Russia’s debt in foreign exchange and domestic currency while also downgrading major Russian banks. In late April, Standard & Poor's downgraded Russia from BBB to BBB-, the lowest investment grade, with a negative outlook. Next, Standard & Poor's similarly revised the investment ratings of Moscow, St. Petersburg33, a number of major Russian companies (including Gazprom, Rosneft, LUKOIL, and Russian Railways), and banks (VEB and VTB). In the cases of Alfa-Bank and Promsvyazbank, Standard and Poor’s only revised the outlook downward. The agency justified its decision by stating, “these companies would be unlikely to withstand a sovereign default, considering their significant dependence on Russia from the operational and financial perspective.”34 During the summer, the three ratings agencies reaffirmed their negative outlooks for Russia. Some politicians and experts have suggested that the ratings downgrade was itself a sanction. However, most believe that the sanctions simply hastened rating agency decisions that would have happened anyway, as the grounds for such actions arose prior to this spring. While “somewhat politically motivated,” the downgrades represented a “response to actual deterioration of our macro situation” according to Alexey Ulyukaev, Russia’s Minister for Economic Development.

33 In June, the Russian regions' movement on the Fitch scale was mixed. 34 In June, S&P slammed lesser players in the Russian financial market; more than half of them (18 out of 32) saw a downward outlook revision.

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Experts believe that a perceptibly higher cost of any external funding for Russia represents a major negative effect of even the “softest” sanctions regime. Foreign loans have been very popular among major Russian businesses to date, given their lower rates and “debt service costs.” According to Bank of Russia statistics, such facilities have accounted for almost nine-tenths of Russia’s aggregate external debt (i.e., $653 billion out of $732 billion). Likewise, there has been a marked deterioration of the environment for new initial public offerings and Eurobond placements against a generally livelier IPO scene in Europe and Asia. In early March, London Stock Exchange flotation of Lenta, a major Russian retailer, precipitated a dramatic drop in its share price. Promsvyazbank, TKS Bank, Bashneft, and Detsky Mir postponed scheduled offerings. As president of the All-Russian Insurers’ Union, I continuously monitor this sector of the domestic financial market. So far, the sanctions have yet to become the primary concern for Russian companies. Ruble depreciation, declining capitalization, and reduced corporate budgets (leading to cuts in insurance costs) have clearly damaged market players in the insurance sector. However, I believe we would still be tallying losses in this area even if Crimea had not happened. Nonetheless, potential downgrades of Russian insurers' international ratings and, going forward, new limits on assumption of Russian reinsurance risks do pose a serious challenge for us. The relatively shallow Russian insurance market is heavily dependent on international reinsurers. So far, corporate insurance remains the only consistently profitable market segment. Difficulties in obtaining reinsurance indemnity from Western partners and resultant bankruptcies of Russian insurers would deal a very heavy blow to the domestic market. The “sanctions regime” is also suspending various processes and postponing decisions crucial for promoting Russia's economic interests. As early as March, the European Commission de facto froze a decision that would have exempted the OPAL gas distribution system in eastern Germany—it transports imported Russian gas southward from the Baltic Sea—from some regulations in the EU’s Third Energy Package. The South Stream project is running into ever-greater obstacles, and Bulgaria has announced the project’s suspension, pending approval by the European Commission.


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Despite some differences in their approaches to sanctions, the United States and Europe have both imposed tight restrictions on any business operations involving Crimea. Although the annexation of Crimea creates mainly local economic challenges for Russia, those challenges are nevertheless exceedingly difficult. Baseline conditions in Crimea, which used to be at least as good as they were across Russia, dramatically worsened in March 2014. Nowadays, Crimea means worn-out infrastructure, a lack of natural resources, dependence on Ukraine for both, inability to raise Western investment, plus vulnerable and tenuous summer tourism that serves as the key pillar of the regional economy and of the livelihoods of a majority of local residents. At the same time, major Russian companies cannot enter the Peninsula directly without risking a Western response. Russia’s development plan for the new Crimean Federal District keeps getting costlier with every successive iteration. At this point, the Russian government has fixed spending at about $20 billion through 2020, but the actual amount of spending will doubtless keep growing. For instance, the estimated cost of the bridge across the Kerch Strait has risen from $3 billion to $4.3 billion to nearly $6 billion. During the design and engineering phase, and during potential construction, the cost will probably escalate again more than once. Economic losses from Russia’s damaged relationship with Ukraine have further tilted the balance. Kiev’s “European choice” made some losses unavoidable, but Moscow has done its best to maximize such losses. Clearly, Ukraine’s own losses will be much more serious, given the different scale of the two economies and the nature of their relationship. However, Russia will also lose a lot—e.g., a major source of raw materials, rolled steel, and machinery components, including defense items. Russian assets in Ukraine, worth at least $30 billion, are now at risk. In late April, a court seized an Odessa refinery that the Russian bank VTB had obtained by way of loan recovery from Sergiy Kurchenko, a fledgling Ukrainian oligarch and ally of former President Viktor Yanukovych who is now a fugitive. Mass-scale asset divestment will probably not happen, but many businesses will find it harder to operate. Ukraine’s role as an interim transportation link between Russia and Europe (and, via the Black Sea ports, other global regions) will probably weaken as well. Since the tragic crash of Malaysian Airlines Flight 17, European leaders have substantially reconsidered their attitudes toward sanctions against Russia. The dominant viewpoint in the United States and the EU is that while separatists

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are directly to blame for the downing of MH17, the Kremlin is the main culprit. The EU’s subsequent adoption of limited, so-called sectoral sanctions, the third and most painful round of sanctions, signals that the conflict between the West and Russia has gained considerable momentum. As a result, Russia faces U.S. and EU economic machines comprising 800 million people on both sides of the Atlantic who together produce half of the world’s wealth. Accounting for just 2% of global GDP, Russia can hardly win such a boxing match—particularly since more than 50% of Russia’s trade turnover is with the European Union. Taxes on the EU’s energy imports make up almost half of Russia’s federal budget. Now, Russian state banks, energy monopolies, and defense companies could be seriously hurt. Refinancing state companies’ $200 billion in debt will already create a serious problem; according to estimates from former Vice Prime Minister Kudrin’s think tank, underinvestment and capital flight caused by the sanctions scare will deprive the Russian economy of another $200 billion. Russian economic experts believe we risk losing up to one-third of our annual budget next year due to international sanctions, in the worst-case scenario. Still, Russia can live with sanctions for the short term. Oil exports still guarantee us a relatively steady flow of income, and hard currency and gold reserves remain at around $500 billion. But the sanctions will eventually hit hard. Both domestic forecasts and estimates from the International Monetary Fund and the World Bank put Russia’s GDP growth at 0.2%, with a probable recession looming. Restrictions on much needed Western investments and technology is a serious impediment. Meanwhile, the sanctions have also solidified Russia’s new and unfavorable position in the system of Western-dominated international, political, and economic relations. Though Russia is not yet considered a rogue nation, many in the West clearly see it as a problem country and an unhelpful actor. Such positioning contributes to worsening conditions on the domestic economic front. Russia’s Responses Notwithstanding the increasing impact of sanctions, President Putin is not likely to change his policy approach under pressure. As Russia’s officials see it, the Iran sanctions and Cuba embargo demonstrate that such a situation can persist for quite some time, especially since Russia is a relatively large and


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wealthy country. With this in mind, the Putin government will not give in to Western sanctions, but will instead look for ways to minimize their impact on Russia and to ensure the survival of the current political and economic system in Russia. Domestically, Putin will try to rally the Russian elite and population around his idea that “Russia is a besieged fortress.” Although it may seem strange to Americans and Europeans, this may actually become an easier sell for Putin as sanctions become more severe, for two reasons. First, tough sanctions will do real damage to Western-oriented internationalists inside Russia. Although there is a new generation of Russian business leaders and so-called global Russians who find Western values to be highly compatible with their mode of life, this group was relatively weak even before the Ukraine crisis. Sanctions have further reduced their voice in debates over Russia’s internal affairs. To stage a comeback, they will have to have some breathing space—something impossible under sanctions that reduce economic opportunities and distort Russia’s political climate. Under harsh and continuing sanctions, this new generation will become weaker and weaker. Russia’s Western-oriented economic elite cannot thrive in isolation from the rest of the world, and Western officials should take note of this. Second, the isolationists around Putin who do not see their future in the wider world are already numerically and emotionally stronger than are modernizers and progressives—and this problem will get worse the longer the sanctions last. That is why the actions already taken by the West have caused a surge of enthusiasm among Russian isolationists. Kremlin efforts to mobilize their support in order to strengthen the political order will further empower them. Neo-conservative Russian isolationists are already influential around President Putin. In the absence of any visible carrots from the West, using the stick endlessly will only strengthen the neo-conservative segment of the Russian elite and population. Russia today is far from the Iranian situation, where the supreme leader decided to avoid selecting a belligerent president to make negotiations possible. In Russia, the current situation can persist for a relatively long time, although the country already feels a strain on its budget and public expenditures. Internationally, the sanctions regime has forced Moscow to look more intensely for new markets and new lenders. The Russian President's recent visit to China is evidence of this. Deeper cooperation with China will have

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costs for Russia—energy experts quickly discovered the secret price per cubic meter of Russian gas deliveries to China, and it was not what Moscow hoped for in the past. The political price for Russia of current and future Russian-Chinese agreements is anyone's guess. The incumbent Russian leadership is unlikely to have any immediate interest in becoming too dependent upon China. However, it may perceive it as the lesser of two evils, as traditional sources of “stability,” the highest value of social life in present-day Russia, are gradually drying up. This forces the government to look for new sources of stability. Russians are already debating the scenario of “Russia as a Chinese political satellite and economic periphery” in earnest, even if most are not yet prepared to accept it. Russia’s recent restrictions on agricultural imports from countries that have imposed sanctions show that Moscow is ready to retaliate economically against the West; beyond this, Prime Minister Dmitry Medvedev has now threatened to restrict access to Russia’s airspace. What are the Russian options if the confrontation over Ukraine continues to worsen? One of the most visible proposals is the Glazyev plan, prepared by Sergey Glazyev, a Russian presidential advisor on economic matters who has been responsible for Russia’s integration plans vis-à-vis Ukraine. Mr. Glazyev has proposed a series of steps to increase Russia’s independence from Western economies and to attempt to damage these economies in the process. His proposed measures included the following:

x move government assets and accounts denominated in U.S. dollars and Euros from NATO countries to neutral nations;

x sell NATO nations’ bonds;; x return state-owned property to Russia; x stop exports of precious metals, rare earths, and other strategic

metals and minerals; x execute currency and credit swaps with China to finance critical

imports; x build a SWIFT-like domestic system for interbank information-

sharing within the Commonwealth of Independent States, along with a domestic payment system;

x work to introduce a capital flight tax; x gradually transition to domestic currency settlements vis-à-vis trade

partners;


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x radically reduce the share of U.S. dollar instruments and debt of other pro-sanctions nations as a percentage of Russia’s foreign currency reserves;

x replace U.S. dollar and Euro-denominated loans of state-owned corporations and state-owned banks with ruble-denominated loans; and,

x transfer offshore-registered titles to strategic enterprises, and transfer mineral rights, real estate, and other property back to domestic jurisdiction.

Russia’s neo-conservative isolationists generally support these measures, which would seek to move Russia’s assets and transactions away from dollars and Euros toward other currencies, develop a parallel international financial system, force Russian businesses and their assets and investment to return to Russia, and keep “strategic minerals” in the country. Sophisticated Russian economic experts, such as former Deputy Prime Minister Alexei Kudrin, have opposing views. They argue that retaliatory measures like these would immediately cause greater losses to the Russian economy and to Russian consumers. However, they say, the best “retaliation” is a “pivot to Asia” and to other emerging economies. The goal of this pivot would be to increase Russia’s finance and trade ties with sovereign funds and public companies from Asian, Latin American, and Arab countries willing to expand their exposure to Russia. Work in this direction has already begun, though it will be difficult to replace the 80% of foreign direct investment in Russia that comes from countries imposing sanctions. Russia also has some other options. First among them is economic retaliation against Ukraine, which Moscow is already doing as part of a wider effort to destabilize that country. Russia has halted trade of more than one-hundred agricultural commodities and industrial products. Moscow has also frozen oil and gas deals and started to look for substitutes for military equipment imported from Ukraine in the past. Russia could still do much more. Ukraine is highly vulnerable because its financial outlook is tragic. Its budget deficit and external debt service require nearly $30 billion. Covering development and recapitalization and addressing structural imbalances in the economy will take almost $200 billion through 2018 due to long-term

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underinvestment, according to some expert views.35 These gigantic amounts are simply unavailable to the European Union, Russia, and Ukraine, even if the United States had the political will to assist. But if nothing is done, the “black hole” of Ukraine’s economy in the center of Europe will drag down the country’s westward and eastward integration and will constitute a long-term economic threat to all. In order to overcome the crisis and the fractures in Europe, it is necessary to create a new platform for cooperation. Both the EU’s Eastern Partnership and Russia’s Eurasian economic integration require serious correction. This may sound unrealistic in the current political environment, but there is no alternative. Moreover, saving Ukraine could actually be the best project to transform the “sanctions regime” back into a “cooperation regime,” something much healthier for the European and global economy. Of course, this will not be possible until governments on all sides—not only Russia—are prepared to adjust their policies. Russia’s most serious economic weapon—restricting oil and gas deliveries to Europe—is a double-edged sword. There is no easily available buyer of this product in Asia because new pipelines or railway deliveries will take years to build. Likewise, export facilities for liquefied natural gas are also pretty scarce. At this point, nobody in his senses openly speaks in favor of cutting off gas supplies to Ukraine, which might take away up to one-quarter of Russia’s federal budget revenues directly or as collateral damage. Nevertheless, Russia could still do this if the conflict deteriorates enough to make the Kremlin’s alternatives look even worse. From this perspective, it can be very dangerous to put too much pressure on Russia. So far, most Russian experts have expressed concern that the Russian Federation cannot respond to Western sanctions without exacerbating the economic damage caused by them. Any actions taken by Moscow to curtail economic and technological cooperation, and any restrictions imposed on Western businesses in Russia would entail immediate losses to the nation's citizens, domestic businesses, and government. Nevertheless, if Russia’s isolationists gain sufficient political influence, these experts may no longer have significant input into policy formulation.

35Kulik S., Spartak A., Vinokurov E., and Igor Yurgens, “Two Integration Projects in Europe: Dead End of Struggle,” INSOR, a summary of a report commissioned by the Civic Initiatives Committee, Moscow, June 2014


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Russia has not yet reached this point. In late May, President Putin used the St. Petersburg Economic Forum as a platform for direct dialogue with Western businesses. He clearly intimated that, so far, the Kremlin does not view an isolationist program as a serious option. Putin insisted that, even in the new environment, Russia intends to follow the motto of “partnership for global development.” Speaking of sanctions, he lamented that “inability to find compromises, unwillingness to take into account partners’ lawful interests, and blunt use of pressure only add to chaos and instability and create new risks for the international community’s continued development.” As he spoke to established Western investors in Russia, Putin asked rhetorical questions. Why do “successful businesses have to suffer losses and relinquish to competitors this huge market and the positions they had built up?” Further, “Does anyone gain from disruptions to regular cooperation between Russia and the European Union? Does anyone gain from seeing our joint work come to a standstill on what are important issues for everyone such as nuclear safety, fighting terrorism, trans-border crime, and drug trafficking, and other priority issues? Is this supposed to make the world any more stable and predictable? Surely it is clear that in today’s interdependent world, economic sanctions used as an instrument of political pressure have a boomerang effect that ultimately has consequences for business and the economy of the countries that impose them.” These pronouncements were completely devoid of any pro-isolationist enthusiasm. The primary effect of international sanctions is partial or complete isolation of the sanctioned nation. Russia is too big to isolate completely, however, and partial isolation is likely to have unintended consequences that contradict U.S. and European intent in imposing sanctions. Should the West strengthen isolationist forces in Russia and provide incentives for Russia's “pivot” away from the West toward China, Latin America, and Africa? This is up to Washington and Brussels.

RUSSIA, UKRAINE, AND U.S. ECONOMIC POLICY

BY BLAKE MARSHALL

Preface The crisis in Ukraine pitting Russia against the West reveals competing narratives regarding precipitants of and reactions to the February ouster of Viktor Yanukovych and the troubling episodes that have since unfolded in Ukraine’s south and east. This paper will assess the economic context of U.S. decision-making in response to the crisis in Ukraine, examining what is at stake economically for both the United States and Russia, the policies pursued and their potential consequences, and options to consider going forward. Introduction For nearly a quarter-century since the breakup of the Soviet Union, the United States and Russia have struggled to adapt to changes to the international system brought about by the Soviet collapse, the end of bipolarity, and the departure from the ‘stability’ of the Cold War era. The Cold War may have been expensive and dangerous, but it was also at least somewhat predictable. Analysts and decision-makers grew comfortable operating within a governing framework of organizing principles built over decades. The purpose and predictability of that framework were not replaced by a set of equally convenient parameters for U.S.-Russia engagement. The bilateral relationship ebbed and flowed through periods of ‘warmer’ ties, which were occasionally buttressed by shared interests, although they were frequently a function of leadership personalities and the relief felt by the absence of conflict. As Russia emerged from a decade of upheaval that was the 1990s, opportunities for more serious common pursuits between Moscow and Washington emerged, yet so too did divergent national interests that were not fully understood without the benefit of hindsight. Cooperative successes were achieved, yet competition and conflict also endured. A decade ago, in June 2004, the Orange Revolution in Ukraine introduced a new variable into Russia’s relations with the West. The view of the world from Moscow changed suddenly and significantly, and subsequent discussion of a NATO Membership Action Plan for Ukraine ensured that this was not a

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fleeting concern in Moscow (and the August 2008 Russia-Georgia war confirmed for U.S. policymakers that we had indeed entered a new phase in the relationship). Through electoral gaming, exertion of economic influence, and leverage of energy supplies, Russia and the West competed in a sometimes subtle and lengthy tug-of-war over Ukraine, culminating in the bidding war between the EU and the Russia-led Customs Union (now the Eurasian Economic Union) last fall, which precipitated the crisis in Ukraine. As pro-EU and anti-Yanukovych protests transformed Kyiv’s Independence Square into the Maidan movement in late 2013, few on either side could have envisioned where U.S.-Russian relations would be in mid-2014, in the midst of the worst crisis since the end of the Cold War, with Ukraine engulfed in a low-grade civil war. Russia’s Economic Backdrop Russia’s Ukraine strategy and the annexation of Crimea in particular have been a boon politically for President Putin at home, as his approval rating soared to 72% in March, 82% in April, and 83% in May. But this conflict comes at a time when Russia can least afford it economically. Russian economic performance has deteriorated since its recovery from the global recession, and the country’s economy has been sliding into a period of stagnation for more than a year now. Whereas Russian GDP grew 3.4% in 2012, growth declined to 1.3% in 2013. The projections for 2014 began at an optimistic 2.5%, but the consensus view has since been reduced by half—to approximately 1.1-1.3%, with the OECD’s revised projection on the low end, at 0.5%. These estimates are not weighted for Ukraine-related risks and impact. Leaving aside the effects of investor behavior and punitive actions taken against Russia, the best-case scenario growth projection hovers around 1.3%. When potential fallout from Ukraine is factored in, this is commonly viewed as enough to tip Russia into recession, with expected performance dropping to -2%. The IMF already considers Russia to be in recession. Bloomberg recently conducted a survey of 10 economists, who assessed the probability of a Russian recession occurring this year to be 33 percent. This same group of economists largely concurred that the consumption effect supporting Russia’s recent rebound has run its course, and that the primary driver of any near-term economic growth must be investment.

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In the second quarter of 2014 (Q2), the Russian economy grew by .8% year-on-year (y-o-y) compared to Q1 2013, the slowest pace in five years since the recession, which followed .9% y-o-y growth in Q1 and a contraction of .5% from Q4 2013. Russian and international observers agree that declining investment is the culprit—Russia’s own Ministry of Economic Development reported that fixed capital investment declined 4.8% in April y-o-y. Russia desperately needs investment to fulfill the sustainable growth imperative and to diversify away from the dominance of the oil and gas sector. Whether ‘real’ foreign investment or repatriated Russian capital (for example, from Cyprus, perennially one of the top ‘foreign’ investors in Russia), capital inflows are the single largest factor impacting Russia’s economic development in the near term. As discussed below, this is the reality in which policy responses to Russia are being formulated, which in turn has Russian officials devising mitigation strategies and counter-measures. Interdependence in a Global Economy The U.S.-Russian economic relationship features only a limited degree of interdependence, at least when analyzed against the likely effectiveness of U.S. sanctions as a strategy in itself—hence the importance of a coordinated multilateral approach with the full support of the EU, in particular. U.S.-Russian bilateral trade remains relatively small compared to both countries’ trade with the EU or China, for example, but the bilateral commercial relationship has experienced a period of rapid growth in recent years, as American and Russian firms alike have benefitted from expanded ties and the development of new markets. After totaling just $24 billion in 2009, U.S.-Russian trade jumped by one-third, to $32 billion, in 2010, and increased again by a similar proportion in 2011 to $43 billion. Since then, however, two-way trade declined to $40 billion in 2012, and dropped another 5%, to $38 billion, in 2013. This year’s performance to date is roughly in line with 2013 (approximately $9 billion in Q1). Each country ranks among the top 25 of the other’s trading partners (e.g., Russia is the 23rd-largest trading partner of the U.S.). While these are not huge export markets, it is also true that the trade relationship has historically tilted in Russia’s favor, with the U.S. running a considerable trade deficit due to imports of Russian commodities (including primarily oil, steel, chemicals, and precious metals). As a result, while the Russian market for U.S. goods and services has continued to expand in the first two years of Russia’s WTO

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membership, it is safe to assume that a smaller swath of Russian companies has more at stake in terms of potential trade disruptions than do their American counterparts, at least in the short run (though many U.S. companies have moved well beyond an initial trading strategy to build market share and are now major strategic investors in Russia for the long term). By contrast, Europe is Russia’s largest trading partner. The comparisons to EU-Russia trade bring into stark relief the importance of a coordinated policy response between the United States and Europe. Russia’s trade with Europe is more than tenfold the U.S. level, at $440 billion, with the EU representing roughly one-half of Russia’s imports and exports. Three-quarters of Russia’s exports to Europe come from its energy sector, as Europe imports roughly one-third of its natural gas from Russia (and half of that amount transits through Ukraine). More specifically, Germany has been a driving force behind European policy on Ukraine due in large part to both its economic clout and its commercial stakes in Russia. Russian-German trade was $111 billion in 2012, before declining to $105 billion in 2013. Also, unlike the U.S. trade deficit, German exports nearly equal the imports from Russia. German business leaders have noted that some 300,000 German jobs depend on the country’s economic relationship with Russia. And energy supplies are a primary constraint on decision-makers, as Germany receives three-quarters of its oil and gas from Russia. Beyond the trade case, equally compelling are the investment data underpinning the EU-Russian economic relationship. Roughly 75% of FDI into Russia originates in Europe, and some 6,000 German companies alone are said to have staked an active presence in the Russian market. The comparison to the EU’s economic clout vis-à-vis Russia clearly establishes the logical difficulty of enacting a unilateral American sanctions strategy that will achieve its desired objectives. Vulnerabilities and Costs Given Russia’s increasing integration into the global economy and the vital link between Europe and Russia, it is not surprising that economic leverage emerged as the primary tool in a coordinated U.S.-European policy response to Russia’s aggression in Ukraine.


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The question, then, is how leverage should be applied in a manner that is based upon realistic assumptions; i.e., how can and should influence be exerted, and toward what end(s)? Once the mechanics of inflicting ‘pain’ on Russian targets are confirmed, what are the costs associated with the action, beyond just the intended target scope—how are they felt and by whom? Just as certain sanctions or the threat of them, if deployed properly, could impose severe costs on Russia, it is also reciprocally true that Russia’s importance to the EU economy and its energy supplies poses serious constraints on how far the EU will move against Russia while simultaneously incurring self-inflicted pain. As sets of Western sanctions are debated, implemented, and expanded, the calculations then shift to Moscow, where President Putin weighs the perceived costs against his objectives on an issue that he considers to be of fundamental strategic importance. It could be that Russia is willing to incur great costs without immediately changing course, as Ukraine is the centerpiece of regional security from Russia’s perspective. U.S. Policy: The Path Taken Ultimately, the goal of U.S. policy should be to elicit changes in Russian behavior, deescalate tensions, and promote a dialogue between Russia and Ukraine in pursuit of a long-term and lasting resolution. In the run-up to Russia’s annexation of Crimea in March, U.S. policymakers and their EU counterparts decided on a two-track response: international isolation of and economic pressure on Russia. The goal of the Western policy response was to punish Moscow and to deter further Russian aggression. But from the outset, the strategy and tactics have suffered from a lack of clarity in both their overall intention and their intended targets. They have also suffered from a timing problem, in that the United States and Europe are seeking to change short-term behavior by imposing costs that escalate over time and that are most significant for Russia in the medium- to long-term. The first steps to isolate Russia in the international arena consisted primarily of what the United States and Europe will not do—in other words, to demonstrate that partnership with Russia has become a thing of the past. The first measure, canceling the G-8 summit that Russia planned to host in early June, effectively expelled Russia from the top-table body in favor of reverting to the G-7 format for the foreseeable future. Other U.S. steps included putting bilateral trade and investment talks and military cooperation

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initiatives on-hold, as well as canceling planned meetings of the U.S.-Russian Bilateral Presidential Commission. On the multilateral front, talks on Russia’s OECD accession were suspended. Russia’s response to these steps was rather predictable and was primarily rhetorical in nature. It consisted of dismissing the importance of some international forums such as the G-8 while combating attempts to unify the Western position. Russian officials made clear that Russia has many trading partners and interlocutors, and that bilateral “boycotts” of previously planned initiatives were unfortunate unilateral decisions to not further develop economic opportunities in and with Russia. The second set of measures was seemingly developed as a hybrid of the dual track: to both isolate Russia and prominent Russian individuals and to exert economic pressure. An executive order on March 6 put in place sanctions in the form of visa bans and asset freezes against those directly involved in Crimea; additional Russian officials and other figures close to President Putin were subsequently designated on the list. The visa bans are of limited utility if they merely restrict travel to the United States, but these travel prohibitions constituted a greater nuisance when the EU followed suit within hours and issued its own list. In themselves, these steps would get Russia’s attention but would not influence Russia’s position. They quickly became viewed as a potential irritant, but not as an actual inconvenience. The Russian response, accompanied by derisive rhetoric, came in classic tit-for-tat diplomatic fashion, with American officials and others soon identified as ineligible for Russian visas. The second set of U.S. responses represented a step up on the severity scale, as the March 6 executive order provided for asset freezes and a prohibition on U.S. persons from doing business with the “specially designated nationals” (SDNs) and entities on the sanctioned list. The initial list of SDNs was quickly expanded within three days to include individuals outside the Russian government and entities whose principals are close to President Putin, including Gennady Timchenko, Arkady Rotenberg, and Bank Rossiya. Additions made to the list in late April included Rosneft CEO Igor Sechin, Rostec CEO Sergey Chemezov, and numerous entities within Gennady Timchenko’s Volga Group. The Russian response to these sanctions was more worrisome to the U.S. business community. Anti-American sentiment escalated, as reflected in the polling trends—from 44% negative bias in January to 71% in May. Commercial retaliation was proposed in the Federal Assembly in the form of


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a draft law permitting confiscation of assets of American and European companies in Russia. When Visa and MasterCard declined to process transactions for Bank Rossiya subsidiaries, the Russian government announced an accelerated plan to develop and implement a Russian national card payment system. Concurrent with the SDN list expansion on April 28, the United States also announced new restrictions on high-tech defense exports to Russia, noting that current export licenses for defense or dual-use technologies that could contribute to Russia’s military capabilities would be revoked and pending applications for export licenses would be denied. The Russian response echoed the Cold War-era rivalry with the U.S., with a reciprocal threat to discontinue sales of Russia’s RD-180 rocket engines for U.S. space launch programs, as well as plans to remove GPS stations in Russia. The mid-March sanctions list and the April addendum also indicated the direction in which the U.S. administration was heading as it threatened further sanctions if Russia refused to halt destabilizing actions in eastern Ukraine. President Obama’s executive order provided a framework for implementing subsequent sanctions as needed: a third wave of more severe sanctions targeting five key sectors of the Russian economy, including defense/high technology, energy, engineering, financial services, and metals/mining. The administration proceeded on this path in July, though the third round did not constitute full sectoral sanctions that prohibited U.S. companies from conducting business in these sectors. Rather, the July steps introduced restrictions on new financing to several banks and energy firms while adding select defense enterprises to the SDN list. Russia responded in August by banning the importation of U.S. agricultural products for one year. Though Russian imports of many American agricultural products (especially meat) have declined in recent years, Russia still represents 10% of U.S. agricultural exports, accounting for some $1.3 billion in sales. Russia’s consumer safety agency subsequently closed 12 McDonald’s restaurants and launched investigations of dozens of others for health and sanitary violations, which was widely perceived as symbolic retaliation (the action against the American fast-food chain included closing the first restaurant opened in 1990 on Moscow’s Pushkin Square). By early September, Rospotrebnadzor’s initial health inspections resulted in the opening of some 80 administrative cases against McDonald’s across Russia.

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Following the NATO Summit in Wales in the first week of September and a tenuous cease-fire in Ukraine, U.S. officials indicated that Washington is “finalizing” new sanctions in coordination with the European Union.36 Further measures have since been put in place.37 U.S. Policy: What Next and Why? An assessment of this two-pronged approach should include not only examination of its effect on desired outcomes but also a clear sense of where the policy is heading along a continuum—an if-then matrix of conditionals that prescribe likely next steps and that are understood by various stakeholders. That concept, at least in its public form, has been lacking in U.S. policy toward Russia in the past few months, specifically with regard to a progression in stepwise sanctions. Policy clarity and public articulation have not kept pace with the rapid developments on the ground and the ongoing fluidity of the situation in Ukraine. In turn, that has made steadfast support more difficult to maintain in American domestic politics, within the U.S. business community, and among transatlantic partners. There have been several instances when both the trigger for sanctions and their ultimate objective have been subject to differing interpretations. First, in the Crimean case, the initial sanctions were announced in March to hold accountable those responsible for coordinating Crimea’s secession and Russia’s annexation of the territory. These steps were, however, accompanied by public statements and pressure from Congress seeking the reversal of the outcome in Crimea as the goal of U.S. policy. If the failure to undo the annexation and to return Crimea to Ukraine were the trigger for an escalating series of sanctions, then clearly sectoral sanctions would have been implemented much earlier in the spring. By the time the reality of Crimea’s new status had been absorbed (if not recognized), at least for the short run, unrest in eastern Ukraine quickly spiraled into a similar scenario. The scenario was similar not in cultural and historical terms, but in terms of mechanics and modus operandi—separatist seizure of local government facilities, hurriedly staged votes for 36 Rebecca Shabad, “U.S. ‘finalizing’ new sanctions against Russia,” http://thehill.com/policy/international/217133-us-finalizing-new-sanctions-against-russia. 37 David Jackson and Oren Dorrell, “Obama team unveils new Russia sanctions,” http://www.usatoday.com/story/news/nation/2014/09/12/obama-russia-sanctions-vladimir-putin/15502067/.


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independence, pleas for Russian support, and well-equipped forces securing key infrastructure and transport routes. In the case of eastern Ukraine, the threshold for implementing sectoral sanctions has been specified over the past months in various terms, including, among other things: 1) Russian attempts to disrupt Ukraine’s May 25 presidential election, 2) Russian support for further destabilizing actions in eastern Ukraine, 3) Russia’s failure to withdraw its forces from forward deployment in regions bordering Ukraine, and 4) a Russian cross-border incursion into Ukraine. When Russia began the process of withdrawing its forces and accompanying equipment from the border and returning them to their home bases, it left the impression that this succession of markers had passed without an overt violation requiring a response. In some sense, then, the policy could be deemed to have been effective, at least insofar as it deterred the worst-case scenarios involving a Russian invasion of eastern Ukraine. It could also be argued that the threat of sectoral sanctions was not a determining factor in President Putin’s decision to withdraw Russian forces from the border. While the spring campaign evidenced rapid rollout of preconceived plans and Spetsnaz-like tactical elements, it is likely that, in strategic terms, President Putin is contemplating a series of long-term moves, as in a lengthy game of chess. In any event, the presidential election in Ukraine on May 25 was considered a limited success under the circumstances, but the situation on the ground in eastern Ukraine did not improve in the election’s immediate aftermath—if anything, the sporadic separatist clashes evolved into a coordinated, quasi-military conflict. Following a G-7 discussion in Brussels and a series of exchanges among heads of state in France in the first week of June, a window for peace talks and an accompanying ceasefire opened briefly. Prior to June 10, momentum was building in Europe (and, to a lesser degree, in the U.S.) for recalibrating policy based on a fresh appraisal of the costs and benefits associated with a potential third round of sectoral sanctions. Officials and observers alike pointed to the absence of an overt cross-border incursion, Russian troop withdrawal from the border territories, and the inauguration of President Poroshenko and Russia’s subsequent recognition of him (including a brief meeting with President Putin). The respite was short-lived. On June 11, a column of Russian tanks reportedly crossed the border into eastern Ukraine through a separatist-

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controlled checkpoint in the Luhansk region. Days later, on June 14, separatists downed a Ukrainian transport plane, killing all 49 servicemen aboard. On June 16, Gazprom announced the cutoff of gas supplies to Ukraine due to nonpayment issues. Amid sharp deterioration of the conditions on the ground, the United States announced new sanctions in mid-July, only to witness a new and tragic turn in the conflict with the downing of Malaysian Airlines Flight 17 in eastern Ukraine, apparently as the result of an accidental missile attack by separatist forces. These developments and Russia’s deepening incursion in Ukraine prior to the recent cease-fire led to tougher sanctions to hold Russia accountable, and there is a growing bipartisan consensus in Congress in favor of the U.S. acting unilaterally, if necessary. Given this context, the following section of this paper examines core principles and objectives in sanctions policy. U.S. Sanctions Policy Of the several principles underpinning successful sanctions policy, two warrant particular discussion in this case: specific targeting, as opposed to a misdirected or blanket approach; and strong consensus behind a uniform multilateral policy, as opposed to mixed menus based on varying levels of commitment, or—worst of all—unilateral sanctions. Unilateral U.S. sanctions primarily penalize American companies and rarely achieve their intended effect. The notion of “targeted” sanctions has a dual meaning. In the first, practical sense, it of course means levying a consequence on those responsible for the offense covered by the sanctions—the assumption being that the designated entities are clearly connected to what happened. In a more general sense, though, sanctions should also be tied to a reasonable likelihood of exerting influence, changing behavior, and fostering desirable outcomes (hence the importance of establishing clear goals at the outset rather than retrofitting the goals to sequential steps). My purpose in writing this paper is not to analyze the specific entries on the sanctioned list; instead, I assume that the SDN lists to date are reasonably accurate. But for purposes of assessing effectiveness and informing policy choices going forward, the cause-and-effect linkage between action and reaction deserves further scrutiny. While the sanctions implemented thus far will no doubt have more demonstrable results in the longer run, U.S. official statements as to their


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effect to date have seemed to make convenient use of Russia’s already-declining economic picture. It is true that Russian capital flight amounted to some $50 billion in the first quarter of 2014—equivalent to the annual total in 2013—but there are two important points to bear in mind. First, the sanctions framework was announced on March 6, with additional financial measures following in mid-March, which means the Q1 flight number was likely 75-85% derived by this stage. More notably, capital flight subsequently decreased in April (as sanctions intensified) and further slowed in May, leading some economists to predict net inflows to Russia in June. These data further support the second broader point, which is that Russian capital flight was well underway in Q1 due to investors’ sense of heightened risk brought about by Russia’s actions in Ukraine—not the U.S. policy response. Similar points can be made with respect to ruble depreciation, as the Russian currency’s value declined by more than 5% against the dollar earlier this year, forcing the Central Bank of Russia to spend tens of billions in reserves (including more than $10 billion in a single day) and to raise interest rates twice, up to 7.5%. However, it is also the case that the ruble has risen by roughly 3.5% since the sanctions were announced in early March. And finally, U.S. officials frequently cite the decline in Russian stock markets as evidence that the sanctions are having a direct impact on company shares. With a few exceptions, however, the primary sanctions targets thus far have been individuals and not companies, and most of these companies are not publicly-traded. While the two indexes in the Moscow Exchange, the MICEX and RTS, suffered steep declines in February as the crisis took hold, the RTS has risen some 15% since the sanctions announcement, and the MICEX rallied 10% in May alone, enjoying its best month in two-and-a-half years. Russian stocks are now up 20% since mid-March, and in the last week of May alone, investors poured $105 million in new money into the Russian markets. Thus, in terms of short-term economic impact, the cause-effect policy linkages are tenuous, at best. Put simply, capital flight and currency pressures are primarily a function of risk perception and a reaction to instability—investors did and do flee temporarily. This is a cost to Russia, but one that Russia imposed on itself. Second, concerning coordinated action among allies, broad multilateral support was difficult to achieve at the outset, though the U.S. administration did an admirable job of cultivating and solidifying European support (particularly British and German) in the face of initial opposition. Also, as

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concerns spread among American companies that Asian competitors might stand to gain from the evolving sanctions policy, Japan subsequently signed on to the effort, though in more limited form. As a statement in principle, U.S. and European leaders reaffirmed the possibility of further sanctions during G-7 discussions and D-Day commemorative meetings in France in the first week of June. The trigger most recently identified is a failure by Russia to cease support for ongoing subversive activities on Ukrainian soil. While this is potentially a blurred “red line,” subsequent developments have clarified that line for many in the U.S. and some in Europe, leading to new sanctions in late July. Now the question is the extent to which it will rally support for European shared sacrifice, such that U.S. policy can avoid the quandary of unilateral sectoral sanctions. Without European support, a further series of steps could include the imposition of secondary sanctions on those European countries continuing their economic relationships with Russia in ways that undermine the U.S. effort (as was the case with the Iran-Libya Sanctions Act in the mid-1990s). Some U.S. Senators have already proposed this in draft legislation.38 Given the substitution effect of Russian partners transferring their business to Asian/European competitors, the cost to American business of a go-it-alone approach would be substantial in the near term and staggering over decades to come, and not simply in terms of shareholder profits but also in export-oriented jobs, just as the U.S. regains the jobs lost during the Great Recession. The stakes in the energy realm are rather obvious; even if the targets are limited to state companies Gazprom and Rosneft, one need only analyze the long-run significance of one project, the Exxon-Rosneft Arctic venture, to advise against the tradeoff. Meanwhile, less attention is paid to potential costs in other identified sectors such as financial services, one that is expected to experience some of the most rapid growth and greatest market-opening opportunity as a result of from Russia’s WTO accession. And the importance of Russian corporate clients to London’s financial community has been a principal concern influencing UK policymakers.

Beyond lost market share, another unintended consequences could be an acceleration of Russia’s version of the “Asia pivot” in its foreign policy

38 Eli Lake, “NATO Plans New Military Outposts to Stop Putin—Just Don’t Call Them Bases,” http://www.thedailybeast.com/articles/2014/09/03/nato-plans-new-military-outposts-to-stop-putin-just-don-t-call-them-bases.html.


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orientation. As noted above, Japanese firms acted quickly in March in seeking to exploit opportunities presented by U.S. sanctions policy. And while the groundbreaking $400 billion Russia-China gas deal was the result of negotiations, it is also safe to say that it received new impetus as a strategic priority this spring to solidify a 30-year hedge for Russian exports. U.S. Policy Options The crisis has now reached a point where pressure on the U.S. administration to take further steps has reached a boiling point. This pressure is particularly intense on Capitol Hill, and leading Democrats have joined the chorus of Republican lawmakers urging the implementation of further sanctions to inflict damage on the energy and financial services sectors of the Russian economy, as well as the defense, engineering and mining sectors. How bad could it get? There is no question that the U.S.-Russian relationship has been seriously damaged, at least in the short run. The policy vectors now being debated will influence where the relationship goes from here, but not nearly as much as Russia’s policy choices will impact its relations with both the United States and Europe. There are three primary scenarios that could unfold in terms of next steps for U.S. policy: a series of measures that stops short of sectoral sanctions (for example, limiting access to international financial markets, stricter enforcement of WTO and other trade rules affecting Russian exports, and a more activist stance on anti-corruption measures); the implementation of the sanctions on the five sectors outlined above;; and a “sanctions-plus” variant that would employ sectoral sanctions as the departure point for a multifaceted response. Some might argue that the recent cease-fire obviates the need for further U.S. sanctions, in that large-scale fighting has subsided and Russia and Ukraine appear to have begun a process of dialogue. Thus far, however, U.S. (and European) officials appear to take the contrary view, imposing additional sanctions as a means to reinforce Ukraine’s negotiating leverage and to press Moscow to discourage cease-fire violations by rebel forces. The congressional pressure is evident in legislation introduced to cancel the Pentagon’s current contract with Rosoboronexport (the arms trading unit of the state-owned corporation Russian Technologies) for the purchase of 30 transport helicopters for the Afghan air force, valued at more than a half-billion dollars. The draft “Russian Weapons Embargo Act” would also forbid

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any new contracts with Rosoboronexport and would prohibit cooperation with any company, domestic or foreign, that conducts arms transactions with Rosoboronexport. This follows the pressure tactics pursued with respect to the Magnitsky List for human rights violations in Russia. Congress stipulated that additional names be appended to the original Magnitsky List of 18 persons by the end of 2013. With bilateral tensions escalating through the winter, the administration lengthened its review and then acted in May, following the implementation of the initial sets of sanctions. Sentiment in Congress is squarely behind sectoral sanctions and possibly a sanctions-plus scenario. The push for sectoral sanctions evolved in two important ways in mid-June: the support became bipartisan, with Senate Foreign Relations Committee Chairman Robert Menendez (D-NJ) urging President Obama in writing to act, preferably with European support, but unilaterally if necessary. The “sanctions-plus” faction is led by Senator Bob Corker (R-TN). An influential group of Republican senators has introduced S. 2277, the “Russian Aggression Prevention Act of 2014.” The bill calls for specific and severe sectoral sanctions on prominent Russian banks and companies, as well as direct military assistance to Ukraine in the form of anti-tank and anti-aircraft missiles and small arms. It further requires the President to accelerate the timetable for missile defense deployment in Europe and to increase U.S. and NATO military support for Poland, Latvia, Lithuania, and Estonia. The bill would also grant Ukraine, Moldova, and Georgia the status of non-NATO ally, similar to that enjoyed by Israel, South Korea, and Japan, and a select group of countries that frequently host U.S. bases. While technically outside NATO’s formal security guarantee umbrella, providing this support would fundamentally alter the geopolitical calculus on Russia’s periphery. In addition to the political-military measures, the bill also requires increased U.S. funding to support civil society and democratization promotion efforts inside Russia, which would clearly pose an irritant to Russia in the wake of increased scrutiny and control exerted by Russian authorities over NGO activities and the expulsion of USAID from Russia a year-and-a-half ago. While the bill as currently structured may be unlikely to pass as a package, it is conceivable that key components could move forward or that variants of it could be adopted if Russia continues to provide materiel support to the separatists in eastern Ukraine. The Obama administration would face a


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difficult political dilemma if the Congress imposed measures harsher than its own. Energy Dynamics The 2014 Russian Aggression Prevention Act also seeks to enhance Europe’s energy security—and thus reduce Russia’s energy leverage—by providing authority for the U.S. to export gas to Europe (and to WTO member countries more specifically). The inclusion of this provision is but one example of a growing transatlantic consensus that both policy changes and infrastructure investments are necessary as part of a multi-pronged response to change the energy dynamics in Europe. The early June G-7 discussions demonstrated a new level of resolve to alter the energy dynamics between Russia and Europe, such that initial steps in 2014 are virtually assured, irrespective of other short- and long-term approaches to resolving the crisis in Ukraine. The G-7 leaders discussed a U.S. plan to lift restrictions on the export of shale gas, while European officials outlined support for building several LNG terminals in Europe and substantial investments in reverse-flow technology from West to East. “The diversification of sources and routes for fossil fuels is essential,” the G-7 communique stated. While longer-term solutions are finalized and implemented, the leaders agreed to develop an emergency response plan for the coming winter of 2014-15, the necessity of which became more apparent when Russia halted gas supplies to Ukraine in mid-June. The twin challenges of increasing supply and diversification of routes have elicited a strengthened commitment to construct new pipelines to transport supplies to Europe from sources other than Russia. The EU is pursuing closer ties to Azerbaijan as it steps up its support for expanding the Southern Gas Corridor for Azeri gas delivery through the Trans-Anatolian gas pipeline through Turkey, as well as the Trans-Adriatic Pipeline running across Greece and Albania to Italy. One interconnector will ship gas from Greece to Bulgaria, and further interconnectors are under discussion. The G-7 meeting in June confirmed support for building additional energy infrastructure on an accelerated timetable, specifically regional and national interconnectors and metering stations to facilitate “reverse flow” of gas through existing pipelines. The reverse flow strategy began with small shipments from Hungary to Ukraine a little over a year ago. By April 2014, Germany began reverse-flow gas shipments to Ukraine via Poland, and at the end of the month, Ukraine and Slovakia signed a deal for reverse-flow

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deliveries to begin this fall. Taken together, the two projects could eventually supply one-third of Ukraine’s annual gas consumption. Since Slovakia has the capacity to expand its reverse-flow commitment, the U.S. and EU will no doubt try to persuade the Slovaks to do just that once the project is up and running. Senior EU officials have also highlighted the need to facilitate gas imports from the U.S., in order to route some of the shale boom production for LNG export. European Council President Herman Van Rompuy has suggested the inclusion of this issue in the U.S.-EU Transatlantic Trade and Investment Partnership (TTIP) negotiations. Though it would take several years to implement given the infrastructure requirements on both sides of the Atlantic, a bold step could be taken this year to amend the U.S. legal framework with bipartisan support. The signal itself, years before the first deliveries would reach the European market, would help facilitate a revamped European energy policy and would alter the equation from the Russian side. Of course, these projects will ultimately succeed only if they are commercially attractive to U.S. and European companies. Though the European energy dilemma primarily centers on natural gas supplies, calls for action similar to lifting the ban on U.S. oil exports are surfacing frequently, with the obvious endorsement of American energy companies. These measures to increase and diversify supply will likely be accompanied by stricter interpretation and implementation of the EU’s Third Energy Package and further constraints on Gazprom’s influence, especially as it concerns the unbundling of ownership and transmission capacity. Conclusion U.S. and European leaders were quick to recognize that there can be no military solution for the crisis in Ukraine. This made international isolation and economic leverage the primary tools deployed to exert pressure on Russia to change course after assessing the costs associated with its destabilizing activity. Russia may have changed tactics, but it is not at all clear that it has backed away from a strategy of promoting instability to influence the shape and direction of post-Yanukovych Ukraine. U.S.-Russia relations have been badly damaged by the crisis in Ukraine, and the mutual grievances felt on both sides increase the probability of sharp responses and further setbacks. Proposals in Congress and elsewhere


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demonstrate the potential for a downward spiral leading to talk of “containment” or “Cold War Lite.” But the damage is not necessarily irreparable. The international isolation of Russia will continue and intensify, though the door to renewed engagement with Russia could reopen if Russia takes concrete steps to deescalate the crisis and facilitates tangible, sustainable progress toward a peaceful and unified Ukraine. The current challenge for U.S. policymakers is to deploy the tactics of international isolation and economic pressure without sacrificing long-term business interests or encouraging, whether intentionally or not, a form of commercial disengagement from Russia. Stepping back from large markets that take years to penetrate carries with it tremendous costs—when market share is ceded to competitors, it is difficult to regain, both in terms of access to opportunities or of consumer brand loyalty. Following the first round of asset freezes, Russian lawmakers quickly realized that an upper house proposal to confiscate assets of U.S. and European firms was short-sighted and ultimately harmful to Russia’s investment climate. If the U.S. implements further sanctions, we can expect to see a concrete but measured Russian response—for example, temporary bans on U.S. participation in Russian government tenders. In view of the first two rounds and the possibility of sectoral sanctions, President Putin has further encouraged Russian energy firms to purchase Russian equipment and services rather than entering into contracts with Western suppliers. These are considerations for U.S. officials as they brief the investment community on increased Russian risk or discuss with American companies the extent of their participation in economic forums such as that held in St. Petersburg in May. Both tactics pose a contrast to typical business-government consultations in European capitals, and they further demonstrate the challenge of a coordinated multilateral approach to limiting collateral fallout. Though there exist some ambiguities and differing interpretations in the narrative of the past six months, it is clear that Russia’s role in the crisis warranted a Western response. The nature of the response (and the Russian response to the Western response) has put the U.S. business community in a difficult position. Corporate executives understand the dilemma, but many of them also recall previous sharp differences between the U.S. and Russia over Kosovo and Georgia, among others. During moments of heightened political tension, and especially during those episodes involving the use of force, commercial interests on both sides point to the economic dimension of the

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bilateral relationship as a ballast when other ties are frayed. Corporations obviously seek to preserve and advance their own interests in growing new markets. However, from a strategic standpoint, more robust economic ties and further integration of Russia into the global economy will quite likely alter the context for adventurous pursuits, competition, and conflict in the future.

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ABOUT THE AUTHORS

Thomas Graham Thomas Graham is a managing director at Kissinger Associates, Inc., where he focuses on Russian and Eurasian affairs. He was Special Assistant to the President and Senior Director for Russia on the National Security Council staff from 2004 to 2007 and Director for Russian Affairs on that staff from 2002 to 2004. From 2001 to 2002, he served as the Associate Director of the Policy Planning Staff of the Department of State. From 1998 to 2001, Mr. Graham was a senior associate in the Russia/Eurasia program at the Carnegie Endowment for International Peace. From 1984 to1998, he was a Foreign Service Officer and served twice in the U.S. Embassy in Moscow. Fyodor Lukyanov Fyodor Lukyanov is Editor-in-Chief of the journal Russia in Global Affairs, published in Russian and in English, and Chairman of Presidium of the Council on Foreign and Defense Policy, one of Russia’s most influential foreign affairs membership organizations. His column appears regularly in The Moscow Times, the Russian edition of Forbes magazine, Rossiyskaya gazeta, Gazeta.ru and on the TV-channel Rossiya-24. A long-time journalist, he was previously Deputy Editor-in-Chief and International Editor of Vremya Novostei and International Editor of Vremya MN. Earlier, he as an editor at International Radio Moscow (Voice of Russia) and a correspondent at the newspaper Segodnya. Blake Marshall Blake Marshall is a leading specialist in U.S.-Russia economic relations based in Washington, DC. His experience advising Western companies over the past twenty years includes positions as Senior Vice President and Managing Director of PBN Hill+Knowlton Strategies and Executive Vice President of the U.S.-Russia Business Council. He has worked closely with a broad range of American companies on their investments in Russia and other markets of the former Soviet Union, with an emphasis on market entry and expansion, business strategy, government relations, and stakeholder outreach.

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Paul J. Saunders Paul J. Saunders is Executive Director of the Center for the National Interest and Director of the Center’s U.S.-Russia Relations Program. As chief operating officer of the Center, he is also a member of its Board of Directors and Associate Publisher of The National Interest, the Center’s award-winning magazine. He has closely observed U.S. policy toward Russia, and Russia’s foreign policy and domestic politics, for over two decades. He served as a State Department Senior Advisor during the George W. Bush administration, from 2003 to 2005. Igor Yurgens Igor Yurgens is President of the Institute of Contemporary Development, President of the All-Russian Insurance Association, and Vice President of the Russian Union of Industrialists and Entrepreneurs, one of Russia’s largest trade associations. In addition, he serves on a Russian presidential council on human rights and as a professor at Moscow’s respected Higher School of Economics. He is a leading authority on Russia’s economy and its international economic relationships. He holds a doctorate in economics.

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ACKNOWLEDGEMENTS

I am deeply grateful to the four paper authors for their insightful and sophisticated contributions to this volume. Ashley Frohwein’s thoughtful and detail-oriented proofreading improved the product significantly, as did Emma Hansen’s compelling cover design. Laura Bate’s careful preparation of the final document was also essential.

Finally, I would like to thank Carnegie Corporation of New York for its important and long-term support of the Center for the National Interest and its work on Russia and the U.S.-Russia relationship.

1025 Connecticut Ave NW, Ste 1200 Washington, DC 20036 www.cftni.org

COSTS OF A NEW COLD WAR

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