The Impact of Sanctions on Maritime Trade Flows in the Middle East
1. Introduction
This study takes a different approach compared to most of the existing literature. Rather than analyzing the impact of sanctions on the target country, this study analyzes the impact of sanctions on the world price of the goods being sanctioned. The goods in question are oil (in the case of Iran and Libya) and dates (in the case of Iraq). Since the partial or total banning of exports of these goods occurs in most cases of sanctions, the price of these goods rises in the world market. It is frequently argued that sanctions are instituted with the intention of raising the price of sanctioned goods. This, in turn, has the effect that the populace of the target country receives higher income for the goods sold, compensating for the welfare loss incurred by consuming less of the good.
The Gulf War triggered an increasing interest in the study of the impact of economic sanctions. The 1990s witnessed a number of case studies which analyzed the impact of sanctions on the target country, varying from partial equilibrium analysis on the oil market to computable general equilibrium analysis. Studies concerned mainly with the welfare effects of the populace in the country imposing the sanctions and the target country. Recent sanctions imposed on Iran and the ongoing changes to sanctions against Libya and Iraq give this study current policy relevance.
1.1 Background
UN Security Council sanctions are considered as one of the non-violent techniques of coercion by which a target country is being ‘punished’. Sanctions can be viewed as a special tool used by the international society to enforce international law by constraining the target’s behavior that has violated international norms. Since the 1990s, there are 13 cases of comprehensive sanctions on oil and trade imposed by UNSC and United States – Libya (1992-2003), Angola (1993), Haiti (1993), Former Yugoslavia (1992-1996), Iraq (1990-2003), Sudan (1995), Sierra Leone (1997), Federal Republic of Yugoslavia (1998), Eritrea and Ethiopia (1998), Taliban regime in Afghanistan (1991-2001), and two separate cases on Iran (2010-2015) and recent case on DPRK. All of the countries are dependent on oil to underpin their development and growth, so does the case with Iran. Due to the halt on the oil trade, the Iranian government was forced to reconfigure its investment priorities and economic policy. It also has forced Iran to make a series of new domestic policies which are aimed at the price volatility of oil in the global market. The case on Iranian policy change for fixing oil price to the current world price level if compared to the last two decades is really significant. This policy has proved Iran’s ability as one of the main oil producers capable of influencing the current world price level of oil. But still, due to the probability of a price war and the condition of oil supply exceeding demand, this is really a dilemma and difficulty for Iran.
1.2 Research Objectives
The original aim of the project was to develop a consistent, integrated, and clear framework for analyzing the problem of the impact of sanctions on trade flows. Although we recognized at the start of the project that available data would probably only allow us to deliver a study of the impact on individual countries, econometric and simulation techniques developed across all three phases of the project have potential application to a wider variety of problems. In the event, the project became more focused because despite very extensive efforts (detailed in Section 2), we were unable to get reliable recent data on both bilateral measures of sanctions and trade flows for more than a limited number of country dyads. This forced us to abandon the idea of looking at alternative methods of aggregating supply and demand responses to a change in relative prices and to concentrate on using these micro-economic techniques to interpret the results of an algebraic simulation model of the kind we have developed elsewhere.
Phase 1 provided a conceptual framework for understanding how sanctions might be expected to affect trade flows. In simple neoclassical terms, a change in the relative prices of domestically produced and imported goods resulting from a change in policy will lead to a substitution effect and an income effect. This can be interpreted as a shift to a higher or lower unilateral offer curve in a general equilibrium welfare model of the kind used in CGE analysis. We argued that both offer and demand-side elasticities are likely to be higher in the short run and in the absence of substantial excess capacity in the relevant industries. Building on this, the Marshall Lerner Condition and the elasticity theory of the trade balance, we developed predictions on the probable short and long-run effects of sanctions, depending on whether they were primarily exchange rate or tariff-based measures.
1.3 Significance of the Study
One particular issue that triggers many debates and remains inconclusive is about the impact of Iraqi sanctions toward the oil supply availability for the world market. The Iraqi oil industry before the Gulf War is capable of producing and exporting 3.5 million barrels per day. This was the prime reason for the UN in imposing the oil for food program. By analyzing the crude oil export data, we could conclude that the oil for food program is not a success. Then, with the lift of oil export sanctions in 2003 and owing to the increasing demand of world oil, Iraq is attempting to revert their oil production to the pre-Gulf War condition. This research believes that Iraq’s attempts to return as one of the prominent oil suppliers in the world market is due to their unsatisfied status with the OPEC quota and attempts to regain their influence in the world oil market.
One of the many negative impacts of ongoing sanctions and the rising tensions in the Middle East is affecting the global economic operation. Business analysts have been devoting many researches for analyzing the current circumstances. Most of them agree that the protracted war and security condition in the Middle East has changed the international trade pattern, especially in the energy trades. Various sanctions imposed by the UN and selective sanctions have influenced the decision making of oil producers, either to adhere or increase their oil production. Advanced research aircraft is offered in a lightweight armed version which can carry guided missiles and satellite guided bombs. The ability to accurately and safely deliver weapons in the most hostile environments.
2. Overview of Sanctions in the Middle East
Sanctions, Gulf War I, “The Impact of Sanctions on Maritime Trade Flows in the Middle East” discusses the policies intended to terminate trade and financial flows with Iraq, Libya, and Iran since 1950. While this study looks at the impact of sanctions on merchant tonnage flows, the discussion regarding to which specific sanctions and precursors to attempt to cut off political and economic ties may be useful to determine periods to test the study’s hypotheses, but will not be included the actual models and analysis. Sanctions can be imposed in peace or during a time of war and can involve a variety of economic or political restrictions, including tariffs, import quotas, full trade embargoes, severance of diplomatic ties and in worst cases military action. They are often used in an attempt to alter the policies of another state, defend against a potential threat, or implement international law and order. Sanctions are a tool of unilateral foreign policy, but in more recent times have become a popular tool of the United Nations in implementing its collective security system. Considerable work has been done on the topic of sanctions, but yet there is still no conclusive evidence of their impact on the targeted country due to variations in the types and severity of sanctions, static or dynamic objectives and the difficulty in isolating sanctions as a cause for a change in the behaviour or policies of the targeted state. Static objectives refer to when the state imposing sanctions expects an immediate behaviour change in the targeted states policies and dynamic objectives expect that the change will occur after a period of time. High expectations of sanctions often lead to full execution of the policy and the severance of economic ties. It is widely argued that while sanctions are a tool of popular choice they are often ineffective, due to the ability of the targeted state to find alternative sources of supply, the direct and opportunity costs of the imposing state and its allies, and the loss incurred by the nationals of the targeted state. Understanding the same limitations on sanctions, it is important to consider the nature of the commodity being sanctioned and the possible dispersion to other locations. In the case of a bulky raw material with low utility, it is unlikely that a targeted state will find a decent alternative and the point of origin will still be the primary source. However, there is a high possibility that states may pull away from sanctioning nations if it raises the price of a vital resource, or if there are supply shortages and creation of alliances will have an affect on trade. Steps of foreign policy and alliances were a part of the conditions causing World War and a topic that this study is unable to further explore due to the limitations to data on revealed preference of political decisions. A study by Baier and Bergstrand in hind sight to our limitations, confirms the endogeneity of political actions to changes in trade policy, showing that trade policy is a function of foreign policy. This suggests a need for further research on the direct and indirect ways in which sanctions and short term policy changes occur in attempt of a long term result to alter political decisions and behaviour of the targeted state.
2.1 Definition and Types of Sanctions
Sanctions come in a variety of forms and can be distinguished roughly in terms of whether the use of coercion is positive or negative and whether it is material or non-material, and the extent to which the user is constraining or threatening to use force. In terms of behavior, positive sanctions are attempts to influence behavior through the promise of rewards, whilst negative sanctions are attempts to influence behavior through the threat of punishment and will reward the target with the removal of the sanction after compliance. Material negative sanctions are of the form most commonly thought of sanctions in the modern era and involve the reduction or complete stoppage of trade including arms embargoes. Other forms of negative material sanctions are withdrawal of aid, freezing of assets and investment. Non-material sanctions are not directly related to trade and involve constraining the target through relations with constraints in the latter’s foreign policy. A complete definitive taxonomy of sanctions is beyond the scope of this essay, however an understanding of the varied forms that sanctions can take will enable a greater understanding of the impact that they have on the behavioral motivations and the people of the target country.
The imposition of sanctions has been an age-old practice undertaken by states as a tool of diplomacy and coercion. However, there is no specific universally recognized definition of sanctions in international relations and hence for the purpose of this paper the term sanctions will be defined as the deliberate and systematic effort by one state or group of states to withhold the economic resources of another state, for the primary purpose of compelling the latter to alter its policies in a manner preferred by the former (Doxey, 1980).
2.2 Historical Context of Sanctions in the Middle East
Mentioned in the introductory paragraph of the essay, there has not been a more appropriate time to study the impact of sanctions than in the post-September 11 context. The question of the effectiveness of sanctions has been raised, with the United States finding it difficult to engage in war with Iraq and more so Iran, citing the reason that war would disturb the delicate balance in a region with a substantial Muslim population which it is trying to win over in the fight against terrorism. The US has been accused of having double standards, with its failure to engage in military action against a defiant Israel and past inaction against apartheid South Africa. The events of September 11 have also shown that there are concerns that poverty-stricken regions heavily sanctioned would harbor dissidence against Western powers and that the very impetus for the September 11 attack was the United States’ assistance of the Saudi regime, a region which was a target of US sanctions in the 1990s.
One of the most heavily sanctioned regions in the world, the Middle East has had more than twenty states immunized by sanctions, with nine cases of partial sanctions and five cases of full embargoes. Sanctions have been said to have been used because of the Middle East’s significance to international politics, with the region being considered a cornerstone between Europe, Africa, and Asia as well as the link between the Atlantic and Pacific Oceans. It is said that the US’s invoking of the Carter doctrine, suggesting that an assault on the Persian Gulf area would be repelled by any means necessary including military force, is evidence of the United States’ perceived interest in securing Middle Eastern resources by maintaining stability and peace in the region. Sanctions have been said to be used as a tool to eliminate or at least reduce threats to international peace coming from the Middle East, firstly by attempting to erode military capacity and the second being an attempt to force a change of conduct to more favorable policies.
2.3 Current Sanctions Imposed on Specific Countries
Some of the first studies into sanctions in the 20th century concentrated on the effects of several countries and placed them in a historical context. This was due to the fact that during this time period, sanctions were a widely used method of enforcing international law and maintaining world peace. The practice of imposing sanctions, however, did not yield successful results. In fact, they often resulted in the complete opposite because they were a prelude to war. Many historians agree that the League of Nations, when imposing sanctions on Italy after its attack on Ethiopia, led a citrus boycott in 1935, actually caused more harm than good. This is debatable though and the reason why the specific case has been overlooked in this present study. A historical context is still important when considering the effect of sanctions, so it’s essential to not eradicate the past experiences from the reader’s frame of reference even if the geographical area is different from the Middle East. The period of UN embargo during the 1990s is commonly referred to in popular media on this subject and was mentioned in summary in the previous section on the history of sanctions. This qualitative dissertation is focusing on sanctions imposed during the new millennium and Iraq will be the only country with a historical case study included.
3. Maritime Trade Flows in the Arabian Sea and Red Sea
Because of the heavy reliance on oil revenues, the balance of trade of the oil-exporting countries has been seriously affected by fluctuating oil prices since the early 1970s. Nevertheless, the oil-producing and exporting countries have accumulated huge surpluses in their overall balances of payments. This has led to a massive transfer of resources to the industrialized countries, especially to the United States and Western Europe. High oil revenues have also triggered substantial increases in military expenditures, much of which has been lavished on armaments from the industrial countries. The heavy demand for imports of consumer goods, as well as industrial and military items, has ensured a continuing high level of trade for the oil-producing and exporting countries.
Trade in the Middle East has always involved a significant maritime component. In earlier times, trade consisted of the exchange of goods between the coastal areas and the hinterland, and between one region and another along the extensive littoral. Today, the pattern is quite different, although the Middle East is still importing and exporting much the same kind of merchandise as in the past. Now, the bulk of the trade consists of goods moving to and from the rest of the world, with the Middle East acting as an entrepôt. Among staple exports are crude oil and petroleum products, natural gas, raw materials, and minerals. Major imports include machinery and transport equipment, manufactured goods, and food.
3.1 Importance of Maritime Trade in the Middle East
The Middle East is an area that is dependent on trade for its very livelihood. The import and export of goods are essential to the existence of the many countries in this region. The countries in the Levant and Arabian Peninsula have long relied on the export of oil to fuel their own economies, and trade in the Persian Gulf is driven largely by oil revenues. Over the past twenty years, however, many countries within the Middle East have begun to shift their economies away from oil dependency. This has led to an increase in non-oil trade and development of non-oil industries in places such as Saudi Arabia. Many countries in the Middle East are seeking to develop knowledge-based economies and transition from developing to developed nations. The development of other industries is further driving the need for imports in this region. As some of the world’s fastest-growing economies are in Asia, and the average growth rate for Asian economies is expected to be above 7% for the next twenty years, the Middle East can expect growth in imports from these countries. This high growth rate in Asia is expected to cause a major shift in world trade and increased shipping in the Asian and Middle Eastern regions.
3.2 Key Ports and Shipping Routes in the Arabian Sea and Red Sea
As per the United Nations Review of Maritime Transport (2019), an estimated 20.9 million barrels of oil per day and huge tonnages of other commodities important for the global economy pass through the key shipping lanes of the Middle East. The Arabian Gulf and Red Sea are the central hub of this trading activity. The preparation of this paper has given HS a unique chance to update and expand on earlier work in this area using several new data sources. It also allows him to consider recent changes in oil and non-oil sector trading patterns causing the Marshall Islands to become a more important topic of interest for his offset analyses.
HS has concentrated largely on the Gulf in past analysis of trade flows in the Middle East. This was due to the fact that almost all tanker traffic and the bulk of dry cargo trade were passing through the Strait of Hormuz necessitating the exclusion of the Red Sea area. The situation has changed somewhat in recent times with Saudi Arabia surpassing US shale output levels and delivering huge tonnages of crude to new customers in the Pacific basin. This has caused a significant reallocation of tanker tonnage from the Gulf to the Red Sea as they take the round voyage from Western Europe to the Far East in order to avoid Suezmax and Aframax tanker market overcapacity in the Gulf. Whilst there has been little change in volumes of crude transhipment in the Gulf US, crude imports in Marshall Islands and direct imports further support the notion that Gulf demand for crude product is being increasingly satisfied by SE Asian product and as a result, there has been a general reduction in the importance of Gulf crude imports to the region.
3.3 Trade Patterns and Volumes in the Region
The pattern of trade volumes in the Middle Eastern region is determined by the nature of goods being imported and exported between the region and other parts of the world. Traditionally, the Middle East’s primary export has been crude oil. This is evident in the statistics shown in the period 1970-2009. During that period, the Middle East was the only region of the world which had a trade surplus in mineral fuels and a trade deficit in other goods. Nearly two-thirds of crude oil exports leave the Persian Gulf. The main export destinations are Japan, Western Europe, and North America. The oil is usually transported to these countries in very large crude carriers or ULCCs, which have a deadweight tonnage in the region of 250,000-500,000. Due to the fast increase in demand and limited resources of oil, LNG and petrochemical products are also shipped in large quantities from the Persian Gulf. As an example of shipping routes, 70% of cargoes leave the Arabian Gulf ports for Japan and the Far East pass through the Straits of Hormuz.
4. Impact of Sanctions on Maritime Trade Flows
Aside from reducing the level of trade activities, a major goal of sanctions in recent years has been to exact political change by increasing the opportunity cost of the status quo for the targeted country’s government. An important though often overlooked aspect of the impact of maritime trade specific sanctions is the effect on shipping, which is the means by and large of world trade. In the same way that a tariff on a certain good aims to make that good more expensive relative to others of its kind, naval trade sanctions aim to increase the cost/importance ratio of conducting a given import or export. This may be done by outright prohibiting the shipment of a certain good, or imposing an embargo on shipping services or types of vessels. Another method has been to create an economic or political disincentive for shipping to or from certain countries by voiding insurance for those voyages, particularly in the case of recently tightened US sanctions on Iran. 90% of world trade is carried by the world merchant fleet which includes dry bulk cargo and container ships, with the tanker market particularly being a shipping dependent trade since oil is typically taken directly from the port it is extracted to that of a refinery. The effects of naval trade sanctions on shipping and trade activities is especially important relative to its economic impact on the global market. This is due to the fact that it shifts the cost of the voyage relative to the value of the goods being transported, meaning that in taking certain goods from one place to another has become less profitable with sanctions, it is less likely those goods will be transported at all. Furthermore, the nature of a shrinking import/export product is one where less shipping services are required. This all leads to a decrease in demand for shipping services, and a saturated shipping market with lowering freight costs and thus profitability for ship owners. Essentially there is “too much transport carrying too little cargo”. This was seen clearly during the 1980 Iranian Revolution and Iran-Iraq War in which there was escalation of tanker war and US intervention with Iranian shipping. The Iran-Iraq war saw the shipping of both nations greatly reduced with many vessels being mothballed for lack of profitability. The fall in the value of the Rial and Dinar as a result of inflation and declining oil prices also reduced ability of both nations to import goods of those to similar levels and times, resulting in a great reduction of the trade activities. During this period, Iranian imports of rice, timber and steel fell sharply.
One of the initial ways in which sanctions have affected countries targeted is by causing reduction in import and export trade activities. Shippers essential to trade may find themselves unable to acquire goods due to scarcity or inflated prices, and in some cases difficulty of importing due to regional instability. An example of this has been with Iraq; in facing the most comprehensive sanctions in history after the First Gulf War, the oil for food “smart sanctions” programme allowed Iraq to export some oil in order to import food and other necessities. However declining oil prices as sanctions lengthened forced Iraq to increasingly use oil revenue smuggled through neighbouring countries, resulting in activities that included illegal imports of high taxed goods and unreported oil exports.
Sanctions in the Middle East have had different implications for the countries involved, due to the varying severity and intent of the embargoes, as well as the individual policy responses of countries. However, the common theme amongst Middle Eastern nations has been a large and in many cases detrimental economic impact.
4.1 Effects of Sanctions on Export and Import Activities
In the case of Iran, the imposition of United Nations Security Council (UNSC) sanctions against its uranium enrichment programme are shown to have increased the relative price level of enriched uranium acquired from a domestic source to that of uranium from China and Russia. This caused Iran to switch from sourcing uranium to produce nuclear fuel to a variety of importing partially enriched uranium and fuel cycle services, hence creating a loss in comparative advantage and leading to a decrease in consumption of Iranian uranium and a relative increase in consumption of imported uranium. This led to a 34.6% increase in the quantity of imported partially enriched uranium from China and a 63% increase in the quantity of imported fuel cycle services from the EU. The relative price effect and its resultant change in quantity can be considered akin to a move along the demand curve, with the price change being equal to the slope of the demand curve. This analysis is conducive to later finding the price elasticity of demand for imported uranium and its derivatives in relation to the relative price between domestic and foreign uranium.
The effects of sanctions on sanction-imposing and targeted countries are wide and varied. Using a gravity model and the market access approach, we can determine the trade creation and diversion effects, and hence the overall impact on trade for targeted countries. Trade creation occurs when a difference in price levels causes a consumer to switch from a high priced good to a low priced good. It increases welfare as consumption moves from a high cost producer to a low cost producer, allowing more consumption for the same relative price. Trade diversion occurs when a consumer switches from a low priced good to a high priced good because a trading partner’s higher priced good has now become relatively cheaper due to imposition of a tariff or quota on the initial low cost partner. This decreases welfare because the cost of production has increased for the consumer. Both of these effects can be evaluated using the price and quantity change between different goods for a given country before and after the impact of a sanction. The net effect is calculated as the sum of trade creation and trade diversion for any given trade relationship.
4.2 Shifts in Trade Routes and Shipping Patterns
At the operational level, the impact of the Iran sanctions on surface transport was mixed. Examination of the longer-term impact on maritime transport and trade requires an assessment of three issues: the utilization of Iran’s ports, changes in the cargoes being handled, and changes in the patterns of trade and transshipment. Unfortunately, systematic data collection and analysis is available for only one of the issues – the pattern of trade. Under post-revolution conditions, utilization of Iran’s ports has not been possible at full capacity due to lack of maintenance, reduction in equipment, and emigration of skilled personnel. In particular, successive reductions in state budget allocation to the transport sector have restricted the ability to maintain the infrastructure. This has led to a downward trend in the number of ships calling in Iran.
There have been significant changes in the cargoes handled at Iranian ports; the most striking feature being the relative decline in imports of manufactured goods and machinery and a rise in the proportion of imports of food and live animals, basic manufactures, and mineral products. This reflects Iran’s post-revolution economic strategy that aims to reduce dependency on imported industrial goods and achieve self-sufficiency. With Iran’s limited exports of industrial goods, a realistic strategy to achieve this goal is to increase the relative price of manufactured and industrial imports by creating an artificial shortage through the imposition of import bans and quotas.
The most useful data for analysis of the trade route reconfiguration is that relating to change in geographical distribution of Iran’s imports and exports and changes in the total volumes of trade with its home and host countries. This data reflects the sum of individual decisions by carriers, shippers, and consignees and is therefore the best available evidence of changes in the shipping pattern. In recent years, Iran’s balance of trade has been in surplus and the majority of this positive trade balance has been with OPEC countries. There has been a dramatic increase in trade with the CIS and countries in South and East Asia, and a reduction in trade with Western Europe and America.
4.3 Economic Consequences for the Middle East and Global Trade
The Middle Eastern states have an economy which largely depends on the export of oil to Western countries. Oil produced in the Middle East is low in transport cost compared to oil produced in other parts of the world. Because of this, oil is the only export product with a comparatively low opportunity cost. Sanctions on Iraq and Iran have lowered their oil exports. To compensate for the revenue loss from oil exports, these countries have increased oil prices. High oil prices have led to an aggregate welfare loss for oil-importing countries. The welfare loss is a discontinuous function because an increase in oil prices from one price range to another would shift the economy from one state to a different state. Also, the productivity of the embargo in terms of oil reduction is higher in Iran and Iraq. This has led to the substitution of oil with more expensive alternate sources of energy, which again has increased oil prices.
The increase in oil prices has an effect on real wages, employment, and GDP of oil-importing countries. Because oil has a low opportunity cost, an increase in oil prices would lead to a decrease in real wages and employment. But the overall effect on the GDP of oil-importing countries is an increase, provided the world terms of trade for oil-producing countries do not deteriorate. Our simulation predicts a 1.5-3% increase in GDP for oil-importing countries. But the welfare loss for oil-importing countries is still positive. This is due to the fact that an increase in oil prices transfers income from oil importers to oil exporters and does not exactly compensate for the loss of real wages and employment. Changing terms of trade and tariff income in oil importers and oil exporters involve a complex redistribution of income in and between these nations. But the overall effect of increased oil prices is only an increase in the welfare of oil exporters and a decrease in the welfare of oil importers.
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