University of Economics, Prague Faculty of Economics
Field of study: Economic Analysis
T HE I MPACT OF E CONOMIC
S ANCTIONS ON R USSIAN E CONOMY
AND R USSIAN R UBLE D EPRECIATION Diploma thesis
Author: Bc. Polina Šarandina
Supervisor: Ing. Pavel Potužák, Ph.D.
Year: 2020
I declare on my honour that I wrote this diploma thesis independently, and I used no other sources and aids than those indicated.
Bc. Polina Šarandina Prague, on 19th August 2020
I would like to express my sincere gratitude to my supervisor, Ing. Pavel Potužák, Ph.D., for his useful comments and beneficial advice.
Abstract
This diploma thesis investigates the impact of the Western sanctions imposed on Russia in March 2014 as a reaction to the Russian invasion of Ukraine and the illegal annexation of Crimea. The economic sanctions were implemented by the United States, the European Union, and a number of international organizations and countries on the various Russian sectors and individuals. This work focuses on the impact of sanctions on the Russian economy in terms of the annual GDP growth rate, GDP per capita growth rate, exports and imports growth rate, and the exchange rate development. As a result, the Russian Federation have registered economic contraction by 3.7%, a decline in nominal exports by 40.02% and imports by 38.75%, and a fall of the Russian ruble by almost a half. Within the framework of the empirical part, this thesis introduces synthetic control subjects by building a model of an alternative Russia in order to estimate the effect of the impositions of sanctions on the real GDP per capita, and on the annual growth of imports and exports of good in services in the Russian Federation. The effect on the Russian currency is being examined using the difference-in-difference method. The results of the model estimations affirm that the impact of the implementation of sanctions on indicators presenting the economic welfare and the international trade, along with the exchange rate, is significant, even though rather in the short run.
Keywords:
Exchange Rates, International Trade, Financial Crisis, Sanctions, Welfare JEL classification:
F31, F4, F47, G01
Abstrakt
Tato diplomová práce zkoumá dopad západních sankcí uvalených na Rusko v březnu 2014 v reakci na ruskou invazi na Ukrajinu a protiprávní anexi Krymu. Ekonomické sankce byly zavedeny Spojenými státy, Evropskou unií a řadou mezinárodních organizací a zemí na různá odvětví a jednotlivce v Rusku. Tato práce se zaměřuje na dopad sankcí na ruskou ekonomiku z hlediska ročního růstu HDP, růstu HDP na obyvatele, exportu a importu a vývoje směnného kurzu. Ruská federace tak zaznamenala hospodářský pokles o 3,7 %, pokles nominálního exportu o 40,02 % a importu o 38,75 % a pokles ruského rublu téměř o polovinu. V rámci empirické části tato práce představuje syntetické kontrolní subjekty vytvořením modelu alternativního Ruska za účelem odhadu dopadu uvalení sankcí na reálný HDP na obyvatele a na meziroční tempo růstu dovozu a vývozu zboží a služeb do a z Ruské federace. Účinek na ruskou měnu je zkoumán pomocí metody rozdílu v rozdílech. Výsledky modelových odhadů potvrzují, že dopad uplatňování sankcí na směnný kurz a ukazatele představující ekonomický blahobyt a mezinárodní obchod je významný, i když působí spíše v krátkém období.
Klíčová slova:
Směnné kurzy, Mezinárodní obchod, Finanční krize, Sankce, Blahobyt JEL klasifikace:
F31, F4, F47, G01 Překlad názvu:
Dopad ekonomických sankcí na ruskou ekonomiku a znehodnocení ruského rublu
Table of contents
Introduction ... 1
1 The theory of international and free trade ... 3
2 Sanctions ... 6
3 Historical background ... 9
3.1 The Ukrainian crisis and annexation of Crimea by the Russian Federation ... 9
3.2 Sanctions imposed on Russia ... 10
3.3 Russia’s response ... 12
4 Impact of sanctions ... 15
4.1 Economic impact of sanctions ... 15
4.1.1 Post-sanctions trends in the Russian economy ... 16
4.1.2 Russia’s international trade ... 18
4.1.3 Russian economic dependence on the oil price ... 21
4.1.4 Russian ruble depreciation ... 23
4.2 Political impact of sanctions ... 24
5 Methodology ... 27
5.1 Synthetic Control Method ... 27
5.1.1 SCM – Review of basic methodology ... 28
5.1.2 Implementation of SCM ... 29
5.2 Difference-in-differences technique ... 30
5.2.1 DID – Review of basic methodology ... 31
5.2.2 Assumptions ... 32
6 Models using the synthetic control method ... 34
6.1 Data ... 34
6.2 Selection of control subjects ... 35
6.3 Parallel trend assumption ... 37
6.3.1 GDP per capita – Parallel trend assumption ... 37
6.3.2 Imports (annual % growth) – Parallel trend assumption ... 38
6.3.3 Exports (annual % growth) – Parallel trend assumption ... 39
6.4 Selection of predictors ... 40
6.4.1 Selection of predictors for the GDP per capita model ... 40
6.4.2 Selection of predictors for the imports and exports growth models ... 41
6.5 Model limitations ... 41
6.6 Model estimation and interpretation of the results ... 42
6.6.1 GDP per capita model estimation ... 42
6.6.2 Imports growth model estimation ... 48
6.6.3 Exports growth model estimation ... 52
6.7 Placebo tests ... 56
6.7.1 Placebo test 1 – change of the intervention period ... 56
6.7.1.1 Placebo test 1 – GDP per capita model ... 57
6.7.1.2 Placebo test 1– Imports growth model ... 59
6.7.1.3 Placebo test 1– Exports growth model ... 61
6.7.2 Placebo test 2 – change of the observed subject ... 63
6.7.2.1 Placebo test 2 – GDP per capita model ... 63
7 Model using the difference-in-differences technique ... 66
7.1 Data ... 66
7.2 Parallel trend assumption ... 66
7.3 Model limitations ... 67
7.4 Model estimation and interpretation of the results ... 68
Conclusion ... 72
References ... 75
List of figures ... 79
List of tables... 81
1
Introduction
The United States of America and the European Union imposed economic sanctions on the Russian Federation in March 2014 as a response to the Russian invasion of Ukraine in February 2014. Sanctions are a significant instrument of foreign policy, allowing to prevent the targeted country from maintaining in further unacceptable behaviour. This diploma thesis elaborates on the impact and effectiveness of the imposed sanctions, the goals that were intended to achieve, and their incidence heretofore. This topic is still relevant, considering the continuance of sanctions until present time.
The theoretical basis of the thesis is rooted in the international and free trade theory and the theory of sanctions, which are described in the first two chapters. The content of the following chapter is a historical background of the Ukrainian crisis and the following actions, particularly implementation of sanctions on Russia and Russia’s consequential response along with counter-sanctions. The last section of the theoretical part investigates the political and economic impact of subsequent coercive diplomatic measures. Other factors causing a decrease in trade volumes between the European Union and Russia, such as the fall of the oil prices and the consequential ruble depreciation, is studied as well.
The change in the exchange rate between the ruble and foreign currencies is assumed to have the most important impact on the price level in Russia and economic welfare of Russian citizens, regarding the dependency of the country on imported goods.
The empirical part of the diploma thesis consists of the review of basic methodology for the techniques used, description of data collected for the selection of control subjects and predictors, possible limitations of the models, the model estimation, and interpretation of the results. The main aim of this section is to calculate the differential effect on the economic development in consequence of the imposed economic sanctions using two empirical approaches. I estimate the effect of the treatment (the sanctions implemented) by comparing the deviations in three macroeconomic variables, such as the GDP per capita, annual percentage growth of imports and exports of goods and services, between Russia (a treatment group) and synthetic Russia (a control group) over time, using the synthetic control method. This estimation enables to observe the possible development of the Russian economy in the case of the absence of sanctions. The last section is directed
2 to the calculation of the treatment impact on the Russian ruble, taking into consideration oil prices decline, and using the difference-in-differences technique. The main source of data and statistical information used in the empirical part of the thesis was the World Bank database.
The main aim of the thesis is to measure the effect of sanctions on the Russian economy, measured by the possible losses of the GDP per person. The second hypothesis is whether sanctions had significant impact on the Russian currency and the volume of the Russian international trade.
3
1 The theory of international and free trade
Traditional theory, both classical and neo-classical, states that free trade between different regions is always to advantage of each trading country and improves welfare of the trading world as a whole. The concept of free trade in political economy is over two centuries old and came from the influence of Adam Smith’s “An Inquiry into the Nature and Causes of the Wealth of Nations” – commonly referred to as “The Wealth of Nations”. Smith (1776) popularized the term laissez-faire and supported the idea of free trade among nations:
“It is the maxim of every prudent master of a family, never to attempt to make at home what it will cost him more to make than to buy… If a foreign country can supply us with a commodity cheaper than we ourselves can make it, better buy it of them with some part of the produce of our own industry, employed in a way in which we have some advantage.”
Adam Smith argued that self-interested competition in the free market would tend to benefit society as a whole by keeping prices at a low level and that the market is driven to produce the right amount of goods and services by the so-called “invisible hand”. By saying: “It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regards to their own self-interest. We address ourselves, not to their humanity but to their self-love, and never talk to them of our own necessities but of their advantages” Smith (1776) emphasized the significance of self-interest, which later leads to the production of goods for trade and to the production of those commodities in as cheap and efficient way as possible.
Smith came with the concept of absolute advantage, meaning the ability of a country to produce a good or service at a lower absolute cost per unit using a lesser quantity of inputs or a more efficient process that the trade partner producing the same good or service. He stated that trade should flow naturally according to market forces and should not be regulated by government policy or intervention. The theory of Adam Smith affirms that with increased efficiencies from the production of goods and services by specialization, people from these countries would benefit and trade would be encouraged. Therefore, the
4 wealth of the nation should not be judged by the amount of gold and silver it has but rather by the living standards of its citizens.
David Ricardo (1817) continued working on the theory of international trade in his book
“On the Principles of Political Economy and Taxation” developing the theory of comparative advantage. Comparative advantage refers to the ability of the economy to produce goods and services at a lower cost than the trade partners, and Ricardo argued that industry specialization combined with free international trade always bring positive results. The difference between two discussed theories is that comparative advantage stresses the relative productivity differences whereas absolute advantage focuses on the absolute productivity.
The theories of Smith and Ricardo assumed that free trade would lead producers and countries to determine which good they could produce more efficiently that would give a country an advantage. The Ricardian theory did not explain the underlying productivity differences that lead to intercountry variations in comparative costs, which in turn give rise to international trade. In early 1900s, two Swedish economists, Eli Heckscher and Bertil Ohlin, developed a theory based on Ricardo’s theory by focusing their attention on how a country could gain comparative advantage by producing products that utilized factors which were in abundance in the country. According to Edward E. Leamer (1995), the basic insight of the Heckscher-Ohlin (HO) model is that trading commodities are in reality bundles of factors (land, labour and capital). Productivity differences themselves are traced to intercountry differences in initial factor endowments of a trading region.
This model states that a country exports those goods whose production is intensive in the country’s relatively abundant factor and import other goods that use intensively the country’s relatively scarce factors. It explains the commodity composition of foreign trade entirely in terms of supply conditions (Blaug, 1992).
In 1954, Wassily Leontief published a study “Domestic Production and Foreign Trade:
The American Capital Position Re-examined" in which he tested validity of the HO theory. The study showed that the United States was abundant in capital compared to other countries and therefore should export more capital-intensive goods and import labour-intensive goods. The analysis became known as the Leontief Paradox because it
5 was the opposite of what was expected by the factor proportions theory, as he found out that the US’s exports were less capital intensive than its imports.
Ricardo’s theory and HO model emphasized trade based on the competitive advantage of countries with discernibly different characteristics. American economist Paul Krugman came with an explanation of trade between countries with similar factor endowment and productivity levels in a 1979 paper “Increasing Returns, Monopolistic Competition and International Trade”. New Trade Theory (NTT) is an economic theory that was developed to predict international trade patterns and was initially associated with Krugman. It is based on assumptions such as monopolistic competition, suggesting that firms are often competing on branding, quality and not just price, and increasing returns to scale, meaning that firms cannot compete against incumbent firms and gain substantial economies of scale. According to NTT, another important concept that gives advantage to countries that import goods to compete with products from home country, are network effects offering increased utility to some goods and services over the others, given the consumers’ preference for diversity.
Marc Melitz (2003) and Pol Antràs (2004) initiated a new trend in the study of international trade introducing “new” new trade theory (NNTT), emphasizing firm level differences in the same industry of the same country. The theory discovered that firms that are engaged in international trade have higher productivity than those firms that produce only for domestic market. A heavy protection given to a domestic industry can suppress the functioning of natural selection and suspend a rise in productivity.
International trade cannon be explained by one single theory and the understanding of trade theories continues to evolve. National governments and companies use a combination of these theories to interpret trends and develop strategies.
6
2 Sanctions
Sanctions are defined as “an economic instrument which is employed by one or more international actors against one another, ostensibly with a view to influencing that entity’s foreign and/or security policy behaviour” (Taylor, 2010, p.12).
Economic sanctions are an important instrument of foreign policy and represent one of the political and economic coercive diplomatic measures in international relations (Reid, 2019). International sanctions are distinct from ordinary protectionist barriers, such as tariffs or quotas, and are designed to support four kinds of foreign-policy goals. The first goal is to prevent the targeted state from carrying out further unacceptable actions.
Deterrence can be done in two ways: by punishment, which changes incentives, and by denial, which weakens capabilities to take further unacceptable actions. The second goal is to reverse past behaviour, which creates new political realities, stakes and commitments. The third goal of imposed sanctions is to change the regime by changing not just the policy itself but the political authority driving it. The last foreign-policy goal is to condemn unacceptable behaviour and reaffirm violated norms and standards (Gould- Davies, 2018).
Various authors (Barber 1979, Caruso 2003, Reid 2019) present different types of sanctions. Caruso (2003) distinguishes between negative and positive sanctions. Negative sanctions are the best-known economic instruments of diplomacy aiming to cause an economic detriment to one or more countries and are generally studied in connection with its efficiency. Positive sanctions, on the other hand, are measures dedicated to encouraging and facilitating cooperation between certain states. Further in this paper the expression “economic sanctions” will be used to designate only negative sanctions, as the thesis is focused on these types of sanctions and their impact on trade and other economic and political aspects.
According to Caruso (2003), we can also distinguish three kinds of sanctions looking at the object of sanctions: boycotts, embargoes, and financial sanctions. A boycott is a restriction of imports of one or more goods from the target country that aims to lower demand for certain goods and attempts to reduce the target country’s foreign exchange
7 earnings and therefore its ability to purchase products. This type of sanctions is the most ineffective one because of the ability of target countries to find alternative markets or arrange triangular purchases. An embargo restricts exports of certain products to the target country, which can be partial or complete. This is the most common technique, and it is usually enforced by a system of export licenses and supporting measures. Financial sanctions restrain or suspend lending and investing into the target economy, impose additional restrictions on international savings, and freeze foreign assets of the target country.
Barber (1979) groups economic sanctions into three categories, which do not exclude each other and can coexist in specific cases. The “primary objectives” are related to actions of governments on whom the sanctions are imposed. The “secondary objectives”
are focused on the status and behaviour of governments directing sanctions. The “tertiary objectives” are concerned with the wider international contemplations relating to the structure of total international system or its parts.
Another way to look at sanctions is from the point of view of Reid (2019) who presents the following types of sanctions: economic, diplomatic, military, sports, and environmental sanctions. Economic sanctions are applied for purely economic reasons and include trade bans, which are often limited to certain sections. Diplomatic sanctions are focused on reducing diplomatic ties and not willing to proceed with mutual international relations. Military sanctions are military interventions that can range from targeted military strikes to arms embargo, and sport sanctions prevent representatives of the affected country from competing in international events. Environmental sanctions may address both economic and political aspects, including trade barriers and restrictions.
International sanctions are compulsory measures imposed by two or more countries upon another country to advance their own perceived interests, and they can include economic manipulation, coercive diplomatic efforts, or preliminaries to war (Reid, 2019). Sanctions are most effective in inducing modest policy change and are more likely to succeed against democratic regimes. These measures may target trade or financial flows, but according to recent evidence (Gould-Davies, 2018), financial sanctions, on their own, are almost as effective as a full combination of trade and financial restrictions. Timing of the sanctions is also essential as it is more efficient to impose high costs in the beginning,
8 which makes it more difficult to remain resilient and withstand the shock. Furthermore, the effectiveness of sanctions increases if the state imposing them has wide international support for their implementation. However, the impact of the sanction’s effectiveness explains only about 15-24% of variation in outcomes and the sufficiency of these measures is still indeterminate (Gould-Davies, 2018).
9
3 Historical background
3.1 The Ukrainian crisis and annexation of Crimea by the Russian Federation
Political crisis in Ukraine started on 21 November 2013 in reaction to the decision of the Ukrainian government to suspend the process of signing an association agreement with the European Union. Ukraine had planned to develop Crimea’s natural gas reserves in two years in a cooperation with the companies of the United States, and that trade agreement with the EU would have impacted Ukraine’s trade agreement with the Russian Federation, which was its biggest trade partner at that time (Fisher, 2014).
This resulted in a mass wave of protests in the centre of Kiev and other cities of Ukraine, which came to be known as “Euromaidan”, which led to the resignation of the elected Ukrainian President Viktor Yanukovych, the overthrow of the Ukrainian Government and deaths of nearly 130 people. The protests were mainly caused by the perception of abuse of power, violation of human rights and widespread corruption in Ukraine, escalating and leading to the 2014 Ukrainian Revolution (Fisher, 2014).
Consequently, the political crisis developed when Russia annexed then-autonomous Ukraine’s Crimean Peninsula in March 2014, stating it was protecting its port access to the Black Sea, after a referendum in which, according to Russian official results, the majority of population of Autonomous Republic of Crimea voted to join the Russian Federation. In April 2014, pro-Russian Ukrainian groups in the Donbass region devolved into a subnational war against the post-revolutionary Ukrainian government. As the conflict enhanced, the Ukrainian opposition grew into a pro-Russian insurrection, which was supported by the Russian Armed Forces and Russian Special Forces. After the annexation and the eruption of separatists’1 insurgencies in Russophone2 regions of eastern Ukraine, the events became international and sanctions imposed on Russia by the European Union and the United States followed (Amadeo, 2020).
1 Separatists are a loose group of ordinary Ukrainians and trained military personnel, who have formed a militia under the command of the pro-Russian rebel commander, Igor Girkin, and are concentrated in the eastern Ukrainian cities of Donetsk and Luhansk (Law, Sharwood, 2014).
2 Russian-speaking
10 3.2 Sanctions imposed on Russia
Since 2014 the United States, European Union and several other countries, including Canada, Australia, New Zealand, Switzerland, Norway, Iceland, Montenegro, Albania and Liechtenstein, have imposed a number of sanctions on the Russian Federation. The main goal was not to impel Russia to end the intervention in Ukraine and return Crimea, but to achieve three aims. The first goal was to decelerate the rate of the Russian military aggression. The second goal was to condemn violation of international law and European norms, and the third to encourage Russia for an enduring settlement by increasing the costs of its behaviour (Gould-Davies, 2018).
Gould-Davies (2018) distinguishes several features of sanctions in terms of their political- economic significance. First important feature is target, meaning that sanctions target individuals and sectors. Individual sanctions prohibit transactions with named state officials, heads of main state companies and heads of major private companies. Economic sanctions imposed on key Russian economic sectors have banned sales of military and dual-use technologies, have restricted short-term financing to the financial services and energy sectors, and have prohibited participation in oil projects involving deep water.
The second major feature is scope. While the EU sanctions apply just to EU citizens and EU-registered companies and organizations, the reach of the US sanctions goes much further. Any individual or company around the world now faces America’s financial restrictions unless in complies with the US own sanctions on Russia. The third important feature of the sanctions is duration. The EU sanctions must be renewed every six months.
Whereas in the United States, Countering America’s Adversaries Through Sanctions Act (CAATSA) transferred substantive power to impose and lift sanctions from the president to Congress, which reduces the likelihood that sanctions will be lifted soon.
The EU and U.S. sanctions have been designed to have maximum impact on the regime and minimize the impact on the population. The targeted sanction focus on well-defined core sectors and companies in the Russian economy in comparison with overall trade embargoes that have broad effects that are difficult to control and maintain. The financial
11 sanctions induce that five state banks cannot raise loans with duration over 30 days in the EU and U.S. capital markets. The energy sanctions are aimed at the oil industry in Russia, which is one of the largest in the world. Even though oil is a homogenous good which is available on the world market and can be replaced, countries are still highly dependent on the Russian pipeline oil and cannot change gas supplier easily (Gould-Davies, 2018).
The European Union has imposed three different sanction regimes in reaction to Russian political behaviour. The first regime is linked to the annexation of Crimea and Russia’s actions in Eastern Ukraine, and states that individuals and legal entities, which have been involved in actions undermining or threatening the territorial integrity, sovereignty and independence of Ukraine, may be listed and have their assets in the EU area frozen. The second regime is linked to Russia’s illegal annexation of Crimea and Sevastopol and imposes restrictions and later a total ban on the import of goods coming from Crimea or Sevastopol to the EU. The third regime is linked to Russia’s actions in eastern Ukraine and introduces economic sanctions restricting the use of EU financial markets, and prohibiting the export of armaments, dual-use goods, and the oil industry equipment (Oxenstierna, Olsson, 2015).
The main aim of the US sanctions was to increase Russia’s political isolation as well as the economic costs to Russia. The basis for these sanctions is three presidential executive orders, which were signed by President Barack Obama in March 2014. Executing these executive orders, the US has continually increased the diplomatic and financial costs of Russia’s aggressive actions towards Ukraine. The sanctions include asset freezes for specific individuals, asset freezes for specific entities, particularly state-owned banks, energy companies and armament manufacturers, restrictions on financial transactions with Russian companies in finance, energy and defence fields, restrictions on exports of oil-related technology and dual-use technology (Oxenstierna, Olsson, 2015).
On 6 April 2018, the United States unilaterally imposed further round of sanctions without preceding EU coordination, designating seven major oligarchs and their companies, as well as seventeen senior government officials. These particular sanctions were justified not as a response to specific Ukrainian events but general Russian political activities in the world, referring to Syrian intervention, cyber-hacking, electoral
12 interference, as well as occupation of Crimea and intervention in eastern Ukraine (Gould- Davies, 2018).
In December 2019, the European Union announced the extension of sanctions until July 2020 and that it would start preliminary work on a global sanctions regime to address serious human rights violations (Kovaleva, 2019). New sanctions are currently under consideration by the United States Congress. The list of sanctioned companies and individuals has been increasing each year and now consists of more than 500 companies and 300 individuals. Since 2014 economic sanctions imposed on the Russian Federation have escalated, expanded, and hardened. Key Russian individuals and sectors now face international environment that is much more unpredictable, stringent, and restrictive (Welt, Archick, Nelson, Rennack, 2020).
3.3 Russia’s response
According to Gould-Davies (2018), Russia has responded to sanctions in four ways;
adaptation, evasion, avoidance, and retaliation, which have produced important second- order effects.
1. Adaptation
Russia has used policies and resources to limit the impact of sanctions, and therefore, directly and indirectly, has bailed out vulnerable banks and companies. After four years, Russia was offering new forms of support through credit lines, reinsurance, and possible nationalization of sanctioned assets. In July 2018, the government offered a new comprehensive plan to fight against the impact of the action, including ways of reducing use of the dollar in foreign trade payments, ending fines on sanctioned companies for not returning hard currency to Russia, ways to support access of sanctioned companies to the domestic financial market, further import restrictions on foreign goods, and measures to reduce dependence on foreign patent holders.
2. Evasion
Russia was seeking ways to induce Western companies to violate sanctions and therefore undermine their implementation by offering proposals to allow companies to dissemble
13 their ownership structure and details of their agreements. However, these measures had adverse consequences, mainly by making parts of the economy less transparent, and they have led to reduction in the attractiveness of Russian companies to both Russian investors and investors from countries not imposing sanctions.
3. Avoidance
Russia strived to mitigate sanctions by finding other international trade partners in order to replace the Western ones. As a result, Russia’s movement towards non-Western countries, especially China and countries in the Middle East as increasingly significant sources of finances, accelerated. Since these states cannot perfectly substitute for Western countries, Russia is now much more economically demanding, allowing China to shape their deepening relationship according to their trading requirements.
4. Retaliation
In August 2014, Russia initiated countersanctions to ban specific food commodities imported from the U.S. and the EU, covering both staples and luxury items. This ban was designed partly to inflict costs that might weaken Western resolve and has become part of Russia’s longer-term import substitution policy. Imports of all agricultural products from the European Union, whether sanctioned or not, fell significantly after 2014 – a consequence of falling incomes and fast ruble depreciation.
There were identified five major effects of Russian countersanctions. Firstly, the countersanctions supported import substitution strategy, which led growth of Russian agricultural industry by 3.2% per annum from 2014-2016. Secondly, the share of imports in total food consumption decreased from over a third in 2014 to just over 20% in the second quarter of 2017. The third main effect was that by 2018, Russian food prices increases were much lower than the overall inflation rate, while by February 2015, food inflation was over 23%. Another effect was that some banned food products from the European Union have made their way to Russia as re-exports from other countries. And finally, as a result of Russian countersanctions, oligarchs, other investors and the Russian government became interested in the agricultural sector, and later has earmarked 242 billion rubles in agricultural support for 2018-2020, focused on rail transportation, subsidized loans, block grants to regions, partial compensation for capital investments and targeted support for dairy farmers (Twigg, 2019).
14 On 16 December 2019, the Russian Government signed Resolution No. 1685, which have expanded an import ban on the Ukrainian goods. These goods are prohibited from entering to Russia if they originate from Ukraine, are supplied from Ukraine or have been in transit through the territory of Ukraine. On the same day, the Russian Government signed Resolution No. 1692, which amended the list of the Ukrainian individuals sanctioned by Russia and the total number now amounts to 574 (Efremov, Bychkov, 2019).
Gould-Davies (2018) states that in sum, Russia’s responses to sanctions have further consequences. These measures will change and reshape the psychology and reality of Russia’s political economy and international relations, leading to isolation from the West and becoming closer to China, but on less favourable terms. The role of the state in the economy will grow further, resulting into greater inefficiency and corruption, less transparency and lower growth. That and growing isolation will necessarily lead to prolonged stagnation of the Russian economy and loss of its international positions.
15
4 Impact of sanctions
4.1 Economic impact of sanctions
Empirical evidence on the effect of economic sanctions is mixed, as trade restrictions can raise costs for the target country but may harm the sanctioning economy as well (Kholodin, Netsunajev, 2018). The costs of sanctions for the economy that decides to implement them are never calculated in advance. Firstly, it is very difficult to estimate their value. Secondly, as a rule, the damage to large sanction economies is insignificant and usually does not exceed 1% of GNP (Hufbauer, 1990). However, if the annual growth is about 1%, as in the European Union and Russia, then the imposition of sanctions can lead to negative growth dynamics for both sides.
The economy of the sanctioning party is usually much larger than the one against which one they are imposed. For comparison: according to the World Bank, Russia (in terms of the current exchange rate in 2019) accounts for 3.07% of world GDP, while EU accounts for 16.05%. Therefore, objectively, the side with a less powerful economy is more vulnerable (Klinova, Sidorova, 2014).
The World Bank argues that Western sanctions have hit the Russian economy through three distinctive channels. First, sanctions have caused volatility on the foreign exchange market and a significant Russian ruble depreciation, which has led to downgrade of Russia’s international reserves and capital flight. Second, the restriction on access to international financial markets has tightened domestic and external credit conditions, which had a negative effect on consumption and investment. These sanctions have the largest impact on the economy mainly in the short run since they repress investment and refinancing of major financial institutions affecting the whole economy. Subsequently, the main income-earning oil company Rosneft is directly targeted by the sanctions together with companies in the defence sector. And third, the crisis of confidence has developed from the sanctions and geopolitical tensions, which resulted in greater uncertainty regarding policy and economic development. Consumption growth and foreign direct investments decreased, in addition trade flows have been affected and
16 imports have decreased because of the ruble depreciation and Russian counter-sanctions (Oxenstierna, Olsson, 2015).
4.1.1 Post-sanctions trends in the Russian economy
Whether and to what extent the targeted US and EU sanctions and Russia’s retaliatory measures have impacted the Russian economy is difficult to assess, as at the same time the sanction came into force, the oil price, which is a major export and source of government revenues in Russia, dropped significantly, affecting the output growth and exchange rates. According to the International Monetary Fund and many economists, the twin shocks of multilateral sanctions and low oil prices were the major driver behind Russia’s economic challenges in 2014 and 2015. In particular, Russia registered:
economic contraction (growth slowing to 0.7% in 2014 and contracting by 3.7% in 2015), capital flight (net private capital outflow from Russia in the amount of 152 billion USD in 2014, compared to 61 billion USD in 2013), ruble depreciation (more that 50% against dollar during 2015), higher inflation rate (increase from 6.8% in 2013 to 15.5% in 2015), budgetary pressures (with the budget deficit increasing to 3.2% in 2015, up from 0.9% in 2013), tapping international reserve holding to offset fiscal challenges (including exclusion from international capital markets, as reserves fell from almost 500 billion USD at the start of 2015 to 368 billion USD at the end of 2015) and more widespread poverty (increase by 3.1 mil. in 2013 to 19.2 mil. in 2015, which represents 13.4% of Russian population) (Nelson, 2017).
17 Figure 1 represents annual GDP growth (based on constant 2010 US dollars) in Russia from 2008 to 2019.
Figure 1: Annual GDP growth in Russia from 2008 to 2019
Source: World Bank, own construction
As a result of economic sanctions imposed in 2014 and other external factors affecting the Russian economy, Russian GDP fell by 2% in 2015. Nevertheless, in the following years the economy of the Russian Federation began to stabilize and reached its pre- sanction level of GDP growth in 2017.
-10,0%
-8,0%
-6,0%
-4,0%
-2,0%
0,0%
2,0%
4,0%
6,0%
2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
GDP growth (annual %)
18 Figure 2 captures the evolvement of Russia’s gross domestic product per capita during the examined period from 2008 to 2019.
Figure 2: Development of GDP per capita in Russia from 2008 to 2019
Source: World Bank, own construction
Again, we can see the decline in the indicator from 2014, which lasted until 2016, when GDP per capita decreased from 11 609 USD to 11 356 USD. From 2017 we can observe persisting growth of the value. According to latest available data, GDP per capita in 2019 reached 12 012 USD, which is higher than during pre-sanctions period.
4.1.2 Russia’s international trade
It is obvious that besides the sanctions and countersanctions, the dynamics of the world trade in influenced by other external and internal processes and factors of the country, such as services, currency, geopolitics, the economic conditions of trading countries and their internal political situations. The diversity and complex interrelations of processes and situations affecting the state complicates the accurate estimation of the impact of a single factor. This measure can be estimated by comparing the periods of actions and omissions and can be applied to the world as a whole. The imposition of sanctions against Russia not only led to a decrease in export and import of the Russian Federation in 2014- 2016, as we can see it in Figure 3, but also to the increasing gap in the rate of change of the considered indicators (Kazantsev, 2019).
9000 9500 10000 10500 11000 11500 12000 12500
2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
GDP per capita (USD)
19 According to the Russian Federal State Statistics Services data, as a consequence of the sanctions, but also due to other external factors weakening the Russian economy, in 2013- 2016 the volume of Russia’ export decreased by 40.02%, imports dropped by 38.75% and the balance of trade of Russia declined by 42.46%. However, as we can observe in Figure 3, there was sharp increase in Russian exports and imports in 2017, meaning that the Russian Federation started to recover from the sanctions.
Figure 3: Development of export, import and balance of trade in Russia from 2008 to 2018
Source: The Russian Federal State Statistics Service, own construction
The Russian Federation is the world’s largest country in terms of geographic area, and it shares land and coastal borders with 16 other European and Asian countries. The restrictions on the foreign trade with the Russian Federation affect the foreign trade operations of many states and cause collateral damage outside the sanctioned country.
Russia’s counter-sanctions also have a negative impact on the world trade. From a continental perspective, 53.5% of Russia’s export by value were delivered to fellow European countries, 38.2% - to Asian countries, and smaller percentages were sent to importers in North America, Africa, Latin America, and Oceania. The latest available country-specific data shows that 63% of products exported from Russia went to importers in China (13.4% of total), Netherlands (10.6%), Germany (6.6%), Turkey (5%), Belarus (4.9%), South Korea (3.9%), Italy (3.4%), Kazakhstan (3.3%), United Kingdom (3.1%), United States (3.1%), Poland (2.9%), and Japan (2.7%).
0 100 200 300 400 500 600
2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Balance of trade (bil. USD)
Export Import Balance of trade
20 The following graph shows the development of the value of exports of five largest Russia’s export trading partners in 2019, which are (except for Belarus) the same as they were in 2013, during the pre-sanctions period. Interestingly, the United States, with its small shares of imports from the Russian Federation and its exports to Russia, suffered significantly less than many countries that joined the US and EU sanctions imposed against Russia. During the period from 2013 to 2016 Figure 4 has captured decrease in the value of export for five observed states. The highest percentage decline in the value of export was in the Netherlands where it decreased by 58%, and in Germany where it decreased by 42%.
Figure 4: The results of foreign trade from 2013 to 2019 of top 5 Russia’s export destinations
Source: Federal Customs Service of Russia, own construction
Applying continental lens, 45.8% of Russia’s total imports by value in 2019 were purchased from fellow European Countries and 43.4% from Asian Trade partners.
Smaller percentages of import sales came from Latin America, Africa, and Oceania.
Figure 5 represents the development of the value of imports of five largest Russia’s import destination in 2019. Again, we can observe the decline in import in all five countries, reaching its maximum in 2016 and growing consequently in 2017. One of the largest trading partners of the Russian Federation before the conflict, until year 2013, was
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2013 2014 2015 2016 2017 2018 2019
Export (bil. USD)
Germany Netherlands China Turkey Belarus
21 Ukraine. However, the value of export from Russia to Ukraine fell by 74% and the value of import fell by 75% in 2016, never reaching its pre-sanction level again.
Figure 5: The results of foreign trade from 2013 to 2018 of top 5 Russia’s import destinations
Source: Federal Customs Service of Russia, own construction
From these results, we can state that sanctions can harm not only those to whom they target, but also their initiators and third parties. The fall in the foreign trade volume of the sanctioning countries with the Russian Federation began in 2014 after the imposition of sanctions, and it reached its maximum in 2016. The trade turnover of the countries with Russia, however, began to grow again in 2017, when the Russian economy began to stabilise, even though the sanctions remained in place.
4.1.3 Russian economic dependence on the oil price
The observed decrease in trade volumes between Russia and other countries is not only due to the imposed sanctions, but also significant economic factors, as the decline of Russian economy caused by the falling oil price, which is a major source of government revenues in Russia, and the following ruble depreciation.
The Russian Federation is the world’s second largest oil exporter. Exports of oil and gas make up around two thirds of the Russian export income and half of the Russian
0 10 20 30 40 50 60
2013 2014 2015 2016 2017 2018 2019
Import (bil. USD)
Germany Italy China USA Belarus
22 government revenue. In attempt to affect the Russian state, sanctions targeted the Russian state-controlled oil companies, Rosneft and Gazprom. However, the development in the Russian oil sector has an impact on the oil itself and on international markets, both for supplies and services. Therefore, the effect of sanctions is significant for both Russia and the global petroleum sector (Fjaertoft, Overland, 2015).
Figure 6 captures the evolution of the Brent oil price (USD per barrel) from 2013 to 2019.
Oil prices dropped from 110 USD per barrel in 2013 to 57 USD per barrel at the end of 2014. We can observe a slight recovery at the beginning of 2015, following the decline throughout the whole year and reaching its minimum at the beginning of 2016. According to latest data of the Central Bank of the Russian Federation, in 2019 the oil was being traded at 66 USD per barrel.
Figure 6: Development of oil price from 2013 to 2019
Source: Investing.com, own construction
The price of oil began to decline due to the excess of supply in the international oil market, which is related to the development of crude oil production in the USA. The United States became full independent from imported oil within few months because of the enormous increase in drilling capacity, and traditional oil exporters had to get off their surplus on the world marked pushing the prices down. It is also important to consider political influences, such as the conflict between the members of OPEC, which increased the
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Mar 28, 2013 June 28, 2013 Sep 30, 2013 Dec 31, 2013 Mar 31, 2014 June 30, 2014 Sep 30, 2014 Dec 31, 2014 Mar 31, 2015 June 30, 2015 Sep 30, 2015 Dec 31, 2015 Mar 31, 2016 June 30, 2016 Sep 30, 2016 Dec 30, 2016 Mar 31, 2017 June 30, 2017 Sep 29, 2017 Dec 29, 2017 Mar 29, 2018 June 29, 2018 Sep 28, 2018 Dec 31, 2018 Mar 29, 2019 June 28, 2019 Sep 30, 2019 Dec 31, 2019
Brent oil price (USD)
23 production of oil in order to cover the defaults in oil dependent budgets inducing subsequent fall in oil prices (Tyll, Pernica, Artlova, 2018).
After the drop in oil prices by more than 50% from 2014 to 2016, the Russian economy faced significant complications of a fiscal nature. The downturn of governmental revenues was partially compensated from the reserved fund, which used to be filled by the revenues from oil exports, which led to the drawing off almost two thirds of disposable funds (Tyll, Pernica, Artlova, 2018). Therefore, the decline in crude oil prices is one of the main reasons for the decrease in the Russian GDP in the period from 2014 to 2016.
4.1.4 Russian ruble depreciation
The Russian ruble is extremely sensitive to the oil price, and as a result the decline in the oil price led to the sharp Russian ruble depreciation. However, given the strong trade connection between the European countries and Russia, sanction shocks can be enlarged not only by the decline in GDP growth, but also by the change in the effective exchange rate. That is why the imposed Western sanctions and the following Russian counter- sanctions could be another reason of a deeper weakening of the Russian currency.
Figure 7 presents the development of USD/RUB exchange rate during the period from 2013 to the end of 2019. We can observe the stronger depreciation of the Russian ruble immediately after the imposition of the first round of sanctions. However, taking into consideration the above-mentioned oil price evaluation, when the oil price decreased after the sanctions implementation, we can register a significant correlation between the oil price and the exchange rate of the ruble. According to the Central Bank of the Russian Federation, the Russian ruble is in a regime of floating exchange rate and the rate was around 30 USD/RUB at the beginning of 2013, depreciating during the period from 2014 to 2016 and reaching its maximum at the beginning of 2016 when the exchange rate was around 70 USD/RUB.
24 Figure 7: Development of RUB to USD exchange rate from 2013 to 2019
Source: The Central Bank of the Russian Federation, own construction
As stated above, the extent to which the US and EU sanctions drove the downturn is difficult to divide from the impact of the oil price drop. However, recently the Russian economy was showing signs of recovery, partially because of the higher oil prices, until 2020, when recession due to COVID-19 drove global oil prices down again.
4.2 Political impact of sanctions
According to the most common definitions, economic sanctions are intentional suspensions, initiated by the government or international organizations, of existing foreign economic relations, which would have occurred in case of the absence of sanctions. Dmitrieva (2015) states that the main purpose of sanctions is to change the policies of the targeted country, including the behaviour of its individual leaders. Specific goals may include the change of regime followed by the change in policy, the cessation of hostilities and the destruction of the country’s military potential. Positive goals are always declared to justify sanctions, such as fight against terrorism, totalitarian regimes or the prevention of a humanitarian catastrophe. The United Nations Security Council considers sanctions as coercive measures aimed to maintain or restore international peace and security and as an alternative to military operations in case of unsuccessfulness of diplomatic efforts.
0 10 20 30 40 50 60 70 80
Mar 31, 2013 June 30, 2013 Sep 30, 2013 Dec 31, 2013 Mar 31, 2014 June 30, 2014 Sep 30, 2014 Dec 31, 2014 Mar 31, 2015 June 30, 2015 Sep 30, 2015 Dec 31, 2015 Mar 31, 2016 June 30, 2016 Sep 30, 2016 Dec 31, 2016 Mar 31, 2017 June 30, 2017 Sep 30, 2017 Dec 31, 2017 Mar 31, 2018 June 30, 2018 Sep 30, 2018 Dec 31, 2018 Mar 31, 2019 June 30, 2019 Sep 30, 2019 Dec 31, 2019
Russian ruble/US dollar (RUB/USD)
25 Smart sanctions are especially eligible in case of an autocratic target regime, where the sanctions should undermine the power of the autocrat and diminish the resources available to the autocrat’s main supporters, without imposing significant collateral damage on the repressed citizens (Kaempfer, 2004). According to Wintrobe (1990, 1998), an absolute ruler uses two key inputs in creation of power, particularly repression and loyalty. Applying this assumption, according to Kaempfer and Lowenberg (2007), it leads to the fact that sanctions can increase the budget of the dictator and thus strengthen his position if he is able to gain some profit accruing from the changes in terms of trade.
Sanctions-induced changes in the price of power have both substitution and income effects on the budget constraint of the dictator. The relative size of these effects determines the impact of sanctions on the magnitudes of power and consumption chosen by the leader to maximize his utility.
Gaddy and Ickes (2014) noted that even though the sanctions may affect the Russian economy, they will unlikely change Vladimir Putin’s political course and behaviour.
After the western retaliatory actions, Putin’s approval rating increased and reached 88%
in October 2014 from initial 69%, before the beginning of the crisis. Some analysts believe that contradictions of the Putin regime will bring about its downfall in 2-5 years, however actually, Vladimir Putin seems politically impregnable for the foreseeable future (Rutland, 2014). As we can see today, due to the 2020 referendum reforming the Constitution of Russia and allowing Putin to run again for two more six-year presidential terms, the president’s presumptions have been confirmed.
The initial Western sanctions were originally aimed at deterring future aggression, encouraging Russia to reach political settlement, discouraging military escalation and reaffirming principles of international order, but these measures have not led to the change in regime either. According to Gould-Davies (2018), the political consequences of these economic efforts so far are not favourable. The Russian Federation has not invalidated its political actions, still occupies Crimea, and maintains military intervention in eastern Ukraine. Sanctions have not succeeded in the most ambitious goal of inducing Russia to reach a political settlement.
26 However, sanctions appear to have terminate Russian escalation. Secrieru (2015) noted that the second wave of sectoral sanctions in September 2014 stopped Russia’s offensive against Mariupol and the threat of new sanctions obstructed the full legitimization of the political structure of separatists in Donbass. But it appears that Russian restraint has been induced not so much by sanctions already imposed, but by the possible threat of more severe measures (Gould-Davies, 2018).
The main beneficiary of the sanctions regime is China. The downturn in relations with West may lead Russia’s ‘turn to east’ is no longer an opportunity but a necessity (Losev, 2014). After longer than a decade of negotiations, China signed a 400 billion USD, 30- year deal to buy natural gas from Russia, which is assumed to be unfavourable to Russia.
The Russian public seems accepting of the turn to Asia, voting for the relations with China as positive, however the majority stands to repairing its relations with the West (Luhn, Macalister, 2014).
It appears likely that the Russian leader prefers the status quo, leaving unresolved the legal standing and practical governance of eastern Ukraine. If this is the case, then the sanctions may be in place for some time.
27
5 Methodology
In the empirical part of my diploma thesis I will observe the effect of implementation of economic sanctions on the Russian real GDP per capita, annual growth of exports and imports, and the exchange rate, using two statistical approaches, the difference-in- differences technique and the synthetic control method. Firstly, I will present the basic concept and mathematical principles of chosen techniques and the reason for their selection. Secondly, I will present chosen data for the estimation, arguments for their selection and consequent manipulation with them. In the end, I will demonstrate the estimation itself, using both statistical methods, the comparison and discussion of the results.
5.1 Synthetic Control Method
As was mentioned above, it is difficult to establish whether the chosen control group is a sufficiently accurate representation of what would occur in the area of the treatment group without the intervention. The synthetic control method (SCM) is an alternative statistical approach used to evaluate the effect of a treatment in comparative case studies. It addresses the problem of the control group selection and provides a data-driven procedure allowing to construct synthetic control units based on a weighted combination of comparison units that approximate the characteristic of the unit which is a subject of the treatment. This method includes elements from matching3 and difference-in-differences technique, and combination of comparison units can be better compared to the unit exposed to the intervention (Abadie, 2020).
The technique was developed by Abadie and Gardeazabal (2003) to examine the economic effects on economic growth, using the terrorist conflict in the Basque Country as a case study. The statistical package Synth was later released to support the implementation of the method and to conduct the synthetic control analysis.
3 The method of data collection and organization designed to reduce bias and increase precision in observational studies in those studies where the random assignment of treatments to units is absent (Rubin, 1973).
28 In the following chapter I will present the formal aspects of the synthetic control method based on the case studies by Abadie and Gardeazabal (2003), Abadie (2010), Abadie, Diamond, and Hainmmueller (2015) and Abadie (2020).
5.1.1 SCM – Review of basic methodology
Suppose that there is a data sample of J + 1 units (e.g. countries): j = 1, 2, …, J + 1. It is assumed that the first unit j = 1 is the “treated unit”, the unit affected by the policy intervention of interest, and units j = 2 to j = J + 1 state for the “donor pool”, the set of potential comparison units not affected by the intervention. We also assume that the data span T periods, including the positive number of pre-intervention periods, 𝑇", and post- intervention periods, 𝑇#. For each unit and time, we define the outcome of interest, 𝑌%&, and for each unit we define a set of k predictors of the outcome, 𝑋#%, …, 𝑋(%, unaffected by the intervention. The (k x 1) vectors 𝑋#, …, 𝑋%)#, collects the values of the predictors for units j=1, … J +1, and the k x J matrix, 𝑋" = [𝑋* … 𝑋%)#], contains the values of the predictors for the J untreated units. The pre-intervention characteristics in 𝑋# and 𝑋"
might contain pre-intervention values of the outcome variable. For each unit, j, and time period, t, 𝑌%&+ is the potential response for the intervention. For the unaffected unit, j = 1, and a post-intervention period, 𝑡 > 𝑇", 𝑌#&. is defined as the potential response under the treatment. Therefore, the effects of the intervention of interest for the affected unit in period t is presented in the following equation (Abadie, 2010):
𝜏#& = 𝑌#&. − 𝑌%&+ (5.1)
It is defined that a synthetic control is a weighted average of the units in the donor pool and can be represented by a (J x 1) vector of weights 𝑊 = 𝑤*, … , 𝑤7)# 8, with
0≥ wj≥1 for j = 2, … J and 𝑤*+ ⋯ + 𝑤7)# = 1. Choosing a particular value for W is equivalent to choosing a synthetic control group. The method selects the synthetic control, W*, that minimizes the difference between the pre-intervention characteristics of the treated unit and a synthetic control given by the vector 𝑋# − 𝑋"𝑊. For m = 1, …., k, 𝑋#B is the value for the m-th variable for the treated unit and 𝑋"B is a 1 x J vector collecting
29 the values of the m-th variable for the units in the donor pool. The vector of weights W*
is chosen to minimize:
(𝑋#− 𝑋"𝑊)′𝑉(𝑋#− 𝑋"𝑊) (5.2)
subject to wj≥ 0 (j=1, 2, …, J) and w1+…+ wj=1. If the number of available pre- intervention periods in the sample is large enough, they can be divided into an initial training period and subsequent validation period. Given a V, W*(V) can be computed using data from the training period, then the matrix V is chosen to minimize the mean squared prediction error produced by the weights W*(V) during the validation period.
5.1.2 Implementation of SCM
The main intuition of the model is that only units that are alike in both observed and unobserved determinants of the outcome variable as well as in the effects of those determinants on the outcome variable must lead to the similar development path of the outcome variable over extensive period of time. When the unit representing the case of interest and the synthetic control unit have a similar type of behaviour over an extended period of time before the treatment, the occurred contradiction in the outcome variable following the intervention is interpreted as induced by the intervention itself.
The first basic step of the approach is to present a conceptual model to make the theory transparent, which allows appropriate independent and confounding variables, referred to as predictor variables in line with Abadie, Diamond, and Hainmmueller (2015), to be included in the analysis. It also confirms that other regions exposed to the intervention are excluded from the donor pool, which is one of the key assumptions of the synthetic control method. The second essential step is to identify potential control units for the donor pool, which are similar to the treated unit in terms of factors affecting the outcome.
In case of insufficient selection of countries into the donor pool, the resulting synthetic control might not represent the country exposed to the intervention appropriately.
The following step is focused on developing the synthetic control itself using the outcome variables from the potential control areas and any other predictor variables chosen, which
30 selects the most applicable weighting of units from the donor pool. After minimizing the difference between the outcome of interest in the treated unit in the pre-intervention period and the weighted control, the post-intervention data can be added, and the outcome analysis can be run. The results of the implemented method can be presented by a graph comparing the post-intervention outcome with the synthetic control outcome (Abadie, Diamond, Hainmmueller, 2015).
Another important step is the validation of the results, which can be performed by the placebo analysis. The implementation of the method involves estimating placebo effects for the donor pool and comparing the size of the initial estimated effect falling into the placebo effects distribution. In case that the intervention is the cause of the observed effect, then the gap between the treated and synthetic control outcome will be the largest for the actual treated unit (Abadie, Diamond, Hainmmueller, 2015).
5.2 Difference-in-differences technique
Difference-in-differences (DID) technique is both the most common and the oldest quasi- experimental research design to evaluate the effects of public interventions and other treatments of interest on some relevant outcome variables. It originated in the field of econometrics, but the logic underlying the technique is called the “controlled before-and- after study” and is dating back to Snow’s (1849) analysis of a London cholera outbreak.
Difference-in-difference estimation makes use of longitudinal data from treatment and control groups to obtain an appropriate counterfactual to estimate a causal effect. DID consists of identifying a specific intervention or treatment (such as a passage of law or enactment of policy) by comparing the difference in outcomes after and before the intervention (pre-treatment and post-treatment periods) for groups affected by it (the treatment groups) to this difference for unaffected groups (the control groups) (Wing, Simon, Bello-Gomez, 2018).
DID estimation is used in observational settings where exchangeability cannot be assumed between treatment and control groups. In the absence of treatment, the
