Why Washington Must Reckon With the Devastating Inflation Its Policies Cause
Around the world, governments are grappling with inflation as supply chain disruptions and the ongoing effects of the COVID-19 pandemic contribute to higher prices for all types of goods. Western politicians have spent the last few months trying to assuage the fears of their constituents, who are unaccustomed to fast-rising prices. Just before Thanksgiving, U.S. President Joe Biden promised “coordinated action … to deal with the lack of supply, which in turn helps ease prices.” French President Emmanuel Macron promised a cash handout to French citizens to ease the pain. British Prime Minister Boris Johnson has told Britons to get tough as there is “no alternative” to inflation.
The panic about the single-digit annual inflation rates seen in the United States and Europe could almost be amusing for the citizens of countries such as Iran, North Korea, Syria, and Venezuela, where double- and triple-digit inflation rates have been the norm for years. But the spectacle of Western politicians expressing such concern over inflation must also be vexing: high inflation rates in those countries, which have contributed to the immiseration of millions of people, have been largely caused by the sanctions policies of Western powers.
Sanctions have become a dominant feature of U.S. and European statecraft over the last 20 years. They have varied effects on the economies of target countries, but high rates of inflation can be observed in all countries under major U.S. and EU sanctions regimes. Inflation can also arise from so-called targeted sanctions aimed at industries or entities that are major sources of revenue for a sanctioned government. Many in the U.S. foreign policymaking community have argued that sanctions must be used “surgically and sparingly” if they are to be effective at ending the supposed bad behavior of certain governments. They imagine sanctions as a smart tool of diplomacy that can extract specific concessions from adversaries with few wider negative consequences. But to the extent that they structurally cause inflation, Western sanctions today are far from surgical or sparing in their implementation.
Stoking inflation is a poor way of denying governments the revenue to fund their proliferation activities, proxies, or repression. Even if inflation eats away at government budgets, the leadership of the targeted countries can choose to cut back on welfare programs or infrastructure investments and continue spending on controversial activities. Elites tend to shrug off inflation, burnishing their fortunes by seeking new rents—and for those who have foreign assets, inflation at home may even be a boon. Instead, sanctions hit hardest for middle class citizens, who struggle to maintain their standard of living as inflation throws the economy into disarray, and those who live in poverty, who struggle simply to survive as the price of bread skyrockets.
This indiscriminate economic hardship might push the frustrated and weary people of a targeted country into the streets—perhaps an unspoken goal of many sanctions programs—but targeted governments have rarely been threatened by sanctions-induced unrest. To make sanctions more humane, policymakers must understand how sanctions spur inflation, driving up the prices of essential goods such as food and medicine. Tens of millions of people around the world experience sanctions as a kind of economic warfare, even as U.S. policymakers continue to believe they are applying sanctions in the interests of diplomacy. Failing to mitigate inflation means that the obvious harms of sanctions policy will continue to outweigh the ostensible benefits.
FROZEN CASH FLOWS
Over the last year, our team has examined the ways sanctions make it harder to buy humanitarian goods such as food and medicine in several countries. This research was intended to study the consequences of sanctions and associated effects, such as private sector de-risking and overcompliance, on the trade of humanitarian goods. It was also meant to propose remedies, such as more expansive licenses and exemptions that would allow more companies to engage in this trade, making these goods more affordable and available even in places under strict international sanctions.
Our initial assumption was that sanctions affect humanitarian trade by creating legal ambiguities that discourage companies and aid organizations from delivering food and medicine to targeted countries. But the global supply chain disruptions caused by the COVID-19 pandemic were a clarifying event. Through extensive source interviews with government officials, aid workers, businesspeople, and medical professionals, we discovered that sanctions drive inflation in three specific ways. First, sanctions damage the financial channels necessary to pay for goods and services quickly and reliably. Second, they undermine supply chains by limiting the number of suppliers and logistics firms willing to facilitate sales of humanitarian goods. Third, they prevent long-term investments in the infrastructure necessary to reduce a country’s reliance on imports. When viewed through the prism of inflation, the economic harms of sanctions, particularly financial sanctions, are surprisingly uniform across countries, suggesting that the reduced affordability and availability of essential goods is not an indirect consequence, but rather a direct effect of sanctions policy. Sanctions are an economic weapon designed to cause inflation.
The impact of sanctions on financial channels, such as the basic correspondent banking channels on which all global trade depends, is perhaps the most intuitive reason for why sanctions cause inflation. Financial restrictions have become the cornerstone of most sanctions programs, particularly those of the United States. Such sanctions aim to limit the ability of a target government to earn and access foreign exchange by cordoning off international transactions with the financial institutions of that country. Given the outsized role of the dollar in the global financial system, such prohibitions, even when applied by the United States unilaterally, can have a dramatic effect on routine international banking as banks shy away from sanctioned countries. This is true even when it comes to exempted areas, such as humanitarian trade.
In Iran, the Trump administration’s “maximum pressure” sanctions campaign at one point made all but 10 percent of Iran’s foreign exchange reserves, which total over $120 billion, inaccessible to the government. In November 2018, the Trump administration reimposed secondary sanctions on Iran, meaning that non-U.S. firms conducting business with designated Iranian entities risked being sanctioned themselves. Since these sanctions have come into force, Iran’s currency has lost around 60 percent of its value. Depressed foreign exchange revenue and an inability to tap reserves combined to create an acute balance of payments crisis. Iran’s weakening currency has made imported goods more expensive. Although Iran has a robust domestic manufacturing base, including in the pharmaceutical sector, producers are still forced to pay higher prices for raw materials and intermediate goods. Paying for these imported goods requires using a small number of willing banks to process Iran-related transactions. Naturally, these banks charge hefty premiums. Importers pass these various transaction costs on to consumers in the form of higher prices.
A similar situation has emerged in Afghanistan. In August 2021, as the Taliban seized power in Kabul, the U.S. Department of Treasury, along with other governments, froze more than $9 billion of Afghanistan’s foreign exchange reserves and international donors withheld more than $8 billion of yearly development and financial assistance that accounted for some 43 percent of Afghanistan’s gross domestic product. These measures, together with capital flight from the country and confusion over what is permitted under the UN and U.S. sanctions against the Taliban, has precipitated a major liquidity crisis and the collapse in the value of the Afghan currency, leading to sharp price increases in the import-dependent country. The collapse in Afghan purchasing power is so severe that the UN Development Program forecasts that 97 percent of Afghans could fall below the poverty line by the middle of 2022.
Sanctions have had similar debilitating effects in Lebanon, North Korea, Syria, and Venezuela. But Western policymakers still view financial restrictions as a targeted measure because of their ostensible aim—to limit government revenues. What goes unconsidered is what happens to government capacity—the ability to manage currency markets, cover fiscal commitments such as food subsidies and health-care budgets, respond to crises, and stem inflation—when financial channels shut down and food and medicine become unaffordable to the general public.
THE SPIRALING COST OF FOOD
Limited financial flows are not the only way sanctions drive up inflation. Even in instances where importers in sanctioned countries can find the means to pay for essential goods, they face constrained options and higher prices. The refusal of banks to process certain transactions involving customers in (or linked to) sanctioned countries will force the exit of many suppliers when sanctions are imposed, even those specializing in humanitarian goods. Finding a new banking channel is not worth the trouble for many food and medicine suppliers, especially in countries where falling purchasing power means lower sales potential. For nongovernmental organizations (NGOs), the additional administrative costs associated with delivering aid in sanctioned countries can likewise spur a decision to curtail operations and focus on other, less encumbered countries. For those who do remain, it can be difficult to find transport companies to deliver the goods and firms to offer insurance for the cargoes. These pressures lead to dramatic changes in food and medicine supply chains, which serve to make higher prices a structural reality—longer and more complex supply chains are inherently more vulnerable to global disruptions, as the COVID-19 pandemic has made clear.
The restructuring of the food supply chain as a result of sanctions has a profound effect on the livelihood of ordinary citizens. As research by our colleague Maria Shagina has shown, in Syria, major grain traders have abandoned the market, leading to an increased reliance on grain imported from Russia, and to a lesser extent, Ukraine. The same shift can be observed in Iran, and in both countries a patchwork of opportunistic and often politically connected suppliers has taken market share for imported grains. These smaller traders lack the economies of scale and global sourcing of the major commodities traders who used to supply Iran and Syria before the imposition of sanctions. Reduced competition, smaller volumes, and greater opportunities for corruption mean that the wheat reaching the Iranian and Syrian markets is more expensive than it ought to be, according to traders we interviewed, hurting the most economically vulnerable in both countries.
The dependence on a smaller pool of suppliers also leaves sanctioned countries vulnerable should their suppliers decide to curb exports, as happened with Russian exports to Syria in 2020. Taken together, these factors drive prices higher. In Iran, food prices rose 130 percent over the course of 2020. In Syria, where the economic collapse is far more dramatic, food prices rose 2,136 percent in the same period. In both countries, food prices have risen faster than general inflation, making clear the failure of Western governments to limit the humanitarian harms of their sanctions programs.
A VICIOUS CYCLE OF UNDERINVESTMENT
In the countries we studied, underinvestment and mismanagement prior to the application of sanctions made economies more vulnerable to financial and supply chain disruptions. A lack of economic planning had left many of these countries overly dependent on imports yet insufficiently connected with the global economy. But the effect of sanctions compounds this lack of foresight: governments under sanctions are less able to fix preexisting problems and ensure that the supply of goods can continue to meet demand.
In the case of food and medicine production, chronic underinvestment in these vital sectors eventually leads to an increasing reliance on imports. In Venezuela, for example, imports today account for 85 percent of the food people consume. This dependence on imports was not an issue when the country was earning prodigious oil revenues, which accounted for around 90 percent of the country’s export revenue the last few years. Flush with cash, then-President Hugo Chavez pursued policies that disincentivized increased agricultural production and drove out foreign investors. There was no immediate political cost because imports were comparatively cheap.
Today, they are not, but any course correction by the government of President Nicolás Maduro is impossible as sanctions strain state resources and stymie new investment. Every year that countries such as Iran, Syria, and Venezuela languish under sanctions is another year that necessary economic reform remains untenable. In this way, sanctions will continue to limit access to essential goods long after they are lifted.
AN INFLATION BRAKE
The U.S. Department of Treasury’s recently completed review of U.S. sanctions policy acknowledged that U.S. policymakers “must address more systematically the challenges associated with conducting humanitarian activities through legitimate channels in heavily sanctioned jurisdictions.” But in hinting at possible solutions, the Treasury Department remains wedded to legal remedies that simply cannot mitigate inflation, which stems from supply chain disruptions and induced fiscal crises. Sanctions policy needs deeper reform.
Sanctions, as applied today, establish high prices as a structural reality and make food and medicine inaccessible to many people. U.S. policymakers should include an inflation brake as an integral part of their sanctions programs—committing to calibrate access to foreign exchange reserves and intervene to support supply chains when disruptions are causing unacceptable increases in the price of food and medicine. They should also start to assess, in a systematic manner, the humanitarian effects of existing and future sanctions regimes.
The U.S. Department of State’s Office of Sanction Coordination should lead an interagency process that monitors prices in the targeted countries in accordance with predetermined limits on acceptable inflation. If it becomes clear that inflation is surging above those limits, several steps can be taken. To permit greater foreign exchange liquidity and lower the cost of imports, Washington could temporarily ease access to foreign exchange reserves or it could temporarily allow the target government to engage again in export activities to earn greater foreign exchange revenues. To address the disruptions within humanitarian supply chains, the United States could issue general and specific licenses and comfort letters—documents that confirm a given transaction does not fall afoul of U.S. sanctions—to a wide range of suppliers, logistics providers, and insurers. Crucially, U.S. policymakers would need to work constructively with banks to ensure that financial institutions are ready and willing to facilitate these necessary transactions, while insisting upon ample due diligence to ensure that only payments for humanitarian goods are processed.
This is a feasible proposal. The U.S. government has moved in this direction before, acting on an ad hoc basis to address shortcomings of various sanctions programs, often at the behest of allies and partners. One prominent example is the Swiss Humanitarian Trade Arrangement, designed to facilitate humanitarian trade with Iran. But inflation is an inherent and not occasional outcome of sanctions policy, and Western governments need to be proactive to prevent dramatic increases in the price of food and medicine. With the credibility of their statecraft at stake, U.S. policymakers can no longer afford to ignore the humanitarian harm of sanctions. It is time to hit the brakes.