Wednesday, October 2, 2024

A glass half-full take on Caucasus sanctions evasion

Ed Conway of Sky News recently published a very good investigation on sanctions evasion being carried out through the Caucasus. He visits the Lars border crossing between Georgia and Russia to document how smugglers are openly moving British and German luxury cars into Russia, in contravention of sanctions on Russian luxury car imports.

In a subsequent interview, Conway describes this as the the "most depressing" bit of journalism he has ever worked on. He agrees with his host that the west's sanctions are "performative," in that they are simply there to make Western voters feel good, but in reality achieve very little. He concludes: "The toughest sanctions regime in history, is anything but..."

For anyone who supports Ukraine's cause, this is all difficult to watch. However, I think that Conway has arrived at a glass half-empty interpretation of the details of his own reporting. What follows is my glass-half-full take on Conway's visit to the Caucasus. What I'm hoping to convey  using the details from his video  is that we (i.e. the West) are doing ok. Yep, we could be doing better (and hopefully will), but let's take heart at what we've achieved to date.

Conway tracks two new Range Rovers being smuggled from Tbilisi, Georgia's capital, northwards to the Lars border crossing with Russia. Prior to Conway making contact with them, the Range Rovers have already been on a circuitous trek. Manufactured in Solihull, UK in 2024, we learn that the vehicles were originally shipped by Jaguar Land Rover to a dealer in a country that does not share a border with Russia, so not Georgia, but perhaps Turkey or the Emirates. Thus the first leg of their journey would have involved a long trip in a container ship or RORO cargo ship from England to Dubai or Istanbul.

In the second leg, the smugglers who acquired the car in Turkey or UAE paid for it to be shipped to Georgia, either by boat or overland.

In the third leg, which is the only leg that Conway observes, two single trucks can be seen transporting each Range Rover through Georgia to the Lars border crossing along a skinny winding road. The Range Rovers are deposited in a parking lot next to a "forlorn" cafe on the Georgia side of the border (the parking lot appears to have no security), and after a few days a new driver is paid to take the car to the Russia side and leave it there. 

The parking lot where sanctioned luxury cars are stored at the Georgia-Russia border

Now the fourth leg begins. Another driver is contracted to bring the vehicle to its final destination in Russia. This last leg is no small trip, with the biggest Russian markets, Moscow and Saint Petersburg, at a distance of 1,800 km and 2,500 km respectively from the border.  

These successive legs add up to an arduous trip. The shipping bill is likely quite large. To boot, along each leg of this journey additional paper work must be completed, insurance purchased, border officials bribed, storage fees paid, transit license plates acquired, and taxes levied. It is Western sanctions that have imposed this haphazard shipping burden and jungle of administration on Russia's trade in Range Rovers.

But compared to what? Understanding the burden we've imposed on Russia requires that we compare the current state of affairs to the one that was taken away; namely, the highly-developed patterns of trade that existed before sanctions were deployed in 2022. As economists like to say, it's the opportunity cost, or the value of the next-best alternative, that represents the true burden of the sanctions on Russia.

What Russia has lost is the full expertise and capital of Western logistics being brought to bear on the problem of bringing Range Rovers as cheaply and rapidly as possible from Jaguar Land Rover manufacturing plants to Russian buyers. This involved Range Rovers being loaded en masse into highly-efficient RORO cargo ships in the UK and sent  not along a circuitous route passing through the Suez Canal or around the Cape of Good Hope  but by the shortest passage possible, the Baltic Sea.

In the pre-sanctions era, vehicles destined for Russian buyers were unloaded at the Port of Saint Petersburg, Russia's second-largest city, or next door at the massive Port of Ust-Luga. So the goods passed through customs just once, rather than multiple times. These two Baltic ports are purpose-built for handling large amounts of vehicles as efficiently as possible. From there the Range Rovers were transferred to their final Russian destination not piece-meal, as appears to be the case with the Lars crossing  but in batches via dedicated rail infrastructure and multi-level car haulers. 

Illicit Range Rovers being transported one-by-one via flat bed truck to the Georgia-Russia border


Thanks to sanctions, Russia's first-choice trade route  optimized over many years of trial and error no longer exists. It's been replaced by an improvised Rube Goldberg trade route involving two much longer sea journeys followed by a crappy single-lane road wending its way through the mountains of Georgia to a border crossing that was never designed to handle large volumes of trade. Once across the border, the contraband cars must be on-shipped using rail or road infrastructure that pales in comparison to the significant economies of scale that characterize the Saint Petersburg/Moscow hub. This is plainly an awful fix.

There's another new cost that needs to be factored in, too: the risk of being caught. Given that it is likely that the dealer in the Emirates or Turkey is part of the sanctions evasion conspiracy, they run the risk of having their dealership status being revoked should Jaguar Land Rover catch them. The dealer will therefore only sell to Russians or other Russian-linked third-parties if the price offered is a high one, enough to compensate them for the risk of losing their franchise.

This extra risk premium, combined with all the additional transportation and intermediation costs listed above, gets embedded into the final all-in price that folks in Moscow will have to pay for a new Range Rover. How high is this price? Certainly much higher than before sanctions were applied. Stephanie Baker, author of Punishing Putin, found in her reporting that western cars in Moscow showrooms were being sold for twice as much as in the U.S. The Times describes luxury Bentleys selling in Moscow for about £400,000 plus £50,000 in VATthe same model costs just £250,000 in the UK.

Think of this extra price wedge as a sanctions tax on rich Russian car buyers. So yes, cars are squeaking through the West's sanctions blockade, as Conway's reporting reveals, but let's not forget that this comes at a big cost.

A 2,000 km drive from Tbilisi to Moscow

The sanctions tax includes another component. A car is not just a one-time purchase. It represents a commitment to make long chain of repairs and tune-ups over its lifetime. Since the new Range Rovers in Conway's video are illicit, they won't qualify for any dealership support. The warranty is probably void, too. Telematic upgrades provided by Jaguar Land Rover servers in the UK have likely been turned off. Furthermore, since Jaguar Land Rover no longer sends parts to the Russian market, all replacement parts will have to be smuggled over the border, the cost of ongoing car servicing ballooning.

So in the end, voters in the West can take at least some pride from what western sanctions have achieved. By sanctioning luxury cars, we've forced Russian elites to divert more of their finite wealth to paying for circuitous, awkward, and risky pathways into Russia. This means these elites have less left over for other things.

Now, that doesn't mean western voters can relax, and Conway's reporting is good fodder for galvanizing voters to ask their representatives for further action. While sanctions have made the pathway for Range Rovers and other goods into Russia a long and winding one, we need to keep making it even longer and more awkward.

For instance, Conway's video teaches us that there is just one way road connecting Russia to Georgia. What a fantastic chokepoint for western sanctions to target! By working more closely with Georgian authorities, the U.S. and its allies may be able to induce them to add a number of frictions to the Lars border crossing, thus forcing car smugglers to divert contraband vehicles to even more roundabout trade routes, the end result being Russian elites paying an ever higher price.

5 comments:

  1. John,
    the stated goal of the sanctions was to "crush" the Russian economy and to prevent the military industry from getting spare parts, not to marginally increase prices of things nobody needs. apart from the fact that all those workarounds will be optimized over time and the costs will slowly fall.

    Don't know whether you have seen this, but the Russian military is larger than BEFORE (and more experienced I might add) (https://www.businessinsider.com/russias-army-15-percent-larger-when-attacked-ukraine-us-general-2024-4).

    penny pinching won't win you wars (nor will moving goal posts)

    further, sanctions lead to countersanctions. Any economist worth his salt should factor in costs, don't you think?

    https://www.independent.co.uk/travel/news-and-advice/british-airways-russia-airspace-ban-china-b2593705.html


    But yeah, some illiterate Georgian smuggler or Turkish car dealer is trembling from beeing caught.

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    1. "...the stated goal of the sanctions was to "crush" the Russian economy and..."

      The stated goal of the UK's 2022 sanctions on luxury goods was to ensure that "oligarchs and other members of the elite, who have grown rich under President Putin’s reign and support his illegal invasion, are deprived of access to luxury goods."

      Making it more difficult and costly to get those luxury goods, as has been done, is to deprive access to them. So they're certainly working. The next step is to progressively tighten them, because as you say, smugglers will optimize their routes, so they need to be periodically disrupted.

      As for Russia's countersanctions, those are far less dangerous than coalition sanctions because Russia is much smaller and has far less to offer the world.

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    2. As if depriving oligarchs, who have no say how the country is run and are hated by the majority of the population. of their toys will change anything - beyond belief!
      I am referring to real sanctions. Secondary sanctions, for instance, were not introduced to "deprive anybody of access to luxury goods", but to enforce compliance as the original goals were not even close to beeing reached.
      What were those goals?
      To quote verbatim from the EU council of foreign ministers (2022)
      “weaken Russia’s economic base, depriving it of critical technologies and markets and significantly curtailing its ability to wage war”
      ..pretty much what I said above...

      It likely the case that countersanctions are less costly - I hope we never find out what an enriched uranium ban by Russia (50 percent of global, non substitutable supply would cost - they still have to be figured in, in a proper analyis.


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    3. I agree that the sanctions on luxury goods are far less important than the sanctions on Russia's military/industrial complex. The topic of this article is luxury goods, which is why I focused on them in my comments.

      Mind you, the same general principles apply to both Russia's imports of luxury goods and its imports of military/industrial goods. Sanctions force imports (luxury or military) to take longer and more roundabout routes into the country, adding to the final cost paid by Russians. By progressively turning the screws, evermore exotic logistics must be used to sneak goods in, their prices forever ratcheting higher. Higher prices for priority components deprive Russia's military/industrial complex of its ability to produce weapons and wage war; for the same budget, a manufacturer can no longer afford to build the same weapon, and will have to skimp and cut corners.

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  2. One thing not mentioned is how sanctions (an idiotic contranym) causes uninvoled third parties to view sanctions-compliant intermediaries as operationally unreliable.
    Those third parties then act accordingly and start to either fault-isolate the intermediaries or cut them out entirely.

    Just this month I was asked by a local manifacturer how to use cryptocurrency like Bitcoin or Zcash to get paid in more timely manner than the forthnight it takes a bank wire to finalize. (Seven or so days for all the compliance checking and seven days or so for the actual transfer via the telephone-game of corrispondance banking.)

    So sanctions slowly lose their effectiveness because real world businesses dealing with concrete practical matters neuter them.
    And I mean all sanctions get diminished in effectiveness. That is, newer sanctions start out at the same diminished level as older sanctions had reached then.

    But please do keep on cheerleading for sanctions as it helps decrease your credibility into irrevelance.

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