The Economic Impact of Trade Embargoes on a Developing Economy
By Ghada Gomaa A. Mohamed
This analytical article analyzes the economic effects of a trade embargo on a developing economy (henceforth referred to as the target country). The term “trade embargo” signifies the partial or complete blockade on the imports and/or exports of a country by one or more countries.
Trade embargoes have many effects for both the country(s) imposing them (henceforth referred to as the targeting country(s)) and the target country. For this reason, when a country decides to impose a trade embargo, it must first of all calculate the benefits and costs of such a move. If the benefits outweigh the costs, then it would impose the embargo. Thus, if countries x and y are the only two partners in international trade, and country x imposes a full blockade on the imports and exports of country y, a blockade would have a completely destructive effect on country y’s international trade. But if country y had other trade partners, then the results of the embargo on the economy of the targeting country would be determined based on the following equation:
The economic effects on the targeting country = a (the economic impact in the target country)
where a represents the relative importance of the economy of the target country in the trade of the targeting one, i.e. its relative importance as an international partner for the targeting country before the imposition of the embargo. The higher the value of a, the more reluctant the targeting country is in its decision to impose the embargo. The targeting country would not impose any embargo if the value of a reaches 1, and would be more inclined to impose one if the value of a decreases. As the value decreases, the more incentive there is to impose the embargo in order to realize certain goals.
In this article, I will analyze the economic impact of a trade embargo on the target country, with the assumption that the targeting country has indeed taken its decision to carry out this embargo, and is expecting its success in affecting the economy of the target country and therefore the attainment of its desired goal from the imposition of that embargo.
The investigation into the economic effects of the trade embargo on the economy of the target country will analyze five points of impact:
1-the size, framework, and geographical distribution of trade
2- the conditions of international trade
3- the balance of payment and the international value of the national currency
4- the national income, its method of distribution, and its effects on economic luxury
5- the distribution of resources and the effects on economic growth
I. Impact on the size, framework, and geographical distribution of the target nation’s international trade:
What is initially expected is that a partial or complete blockade on the target country’s imports and/ or exports would lead to a decrease in the volume of international trade (as demonstrated in the decrease of the actual amount of international trade in the target country) in the short term. For example, the United States General Accounting Office announced that the U.S.’s 1985-1990 trade embargo against South Africa resulted in a $417 million decline in that country international trade (Shepherd 1991).
Yet the rate of decrease of the size of international trade in the target country depends on a number of factors, the most important of which are:
1- the relative importance of the targeting country(s) in the economy of the target one
2- the existence of countries that are neutral or in alliance with the target country
3- the possibility of smuggling goods from and to the target country.
If the trade embargo is imposed by all trade partners of the target country and is on all imports and exports, if there is control over the smuggling of these goods from and to the target country, and if there is no interference on the part of neutral countries, then a decline in the size of the target country’s international trade to zero would be expected. But this is a very unrealistic extreme case, especially if the target country has a relatively high proportion in the international trade of the targeting countries (thereby affecting their economic situation). In such a case, the embargo would not be comprehensive on all goods and not imposed from all countries. Also, it may be possible to smuggle blockaded goods from and to the target countries through international intermediaries, despite the target country having to obtain the sanctioned goods at very high prices that by far outweigh their value. Furthermore, it would have to sell its exports at prices that are much lower than their international value (Kaempfer & Lowenberg, 1992, p. 63). The target country may also import the blockaded goods from neutral countries, if they have alternate goods there. Likewise, it can export blockaded goods to these neutral nations, if they have a need to them (Midlicott, 1959). All the previous factors have as their goal the decrease of the average size of the target country’s international trade, and they may prevent it from reaching a point of self-sufficiency.
If we look at the framework of the target country’s imports and exports, we find that the impact of the trade embargo on it depends on a number of factors, the most important of which are:
1- the availability of alternate export and import venues for the blockaded goods
2- the possibility of smuggling the blockaded goods from and to the target country
3- the flexibility of the production mechanism in the target country, and the fluidity of the production factors within various economic sectors.
If an embargo is imposed on the import or export of a certain good in the target country, then what would be expected is that this good would disappear from that country’s international trade in the short term, due to the assumption that there would be no alternate venues for the import of the blockaded good, and no possibility for the smuggling of this good from or to the target country (Midlicott, 1959, p. 36).
In the case where the target country were able to find alternate venues for the import and export of the blockaded goods, or if it can find a way of smuggling these goods from and to the target country, the international trade framework of the target country may be altered.
If the target country is able to produce goods that would substitute for the blockaded imports, or alternate goods to its usual exports for which there would be a market among other countries not involved in the blockade, then the framework for the target country’s trade could be altered.
However, if the trade embargo is not complete in the geographical sense, then the target country may be able to redistribute its international trade to countries with which it has not dealt before and in which it may be able to open new markets. This depends on the availability of such new markets, whether for imports or exports.
II. Impact on the conditions of international trade
The analysis of the effects of a trade embargo on the conditions of international trade in the target country depends on the following variables:
1- the relative weight of the targeting countries within the trade of the target country
2- the possibility of smuggling blockaded goods from and to the target country
3- the interference of neutral countries in trading with the target country.
If we assume that the targeting countries impose a complete trade embargo on the target country (on all imports and exports), that there are no venues for smuggling blockaded goods to and from that country, and that neutral countries do not interfere in trading with the target country, then in this case the target country will be forced to the point of self-sufficiency, and as a result the conditions of its trade will deteriorate vis-à-vis the pre-embargo rate of international trade to the internal rate of international exchange in it.
With regard to more realistic assumptions, such as an embargo that is partial with regard to geography or goods, the intervention of neutral countries in trading with the target country, or the possibility of smuggling blockaded goods from and to the target country, this would decrease the price of the target country’s exports and increase the price of its imports, i.e. bring about the deterioration of its trade conditions.
III. The Impact on the balance of payment and the international value of the national currency
The trade embargo includes blockades on the imports and/ or exports of the target country, which affects the balance of payment of the target country due to the impact on the current account. This is because such an embargo can affect concrete and inconcrete goods, as in the case of the air embargo that the United States imposed on Libya in 1990 as a result of the Lockerby incident.
Here, I will limit my analysis to the embargo on concrete imports and exports only, since these were the most abundant in previous embargo cases. The analysis here depends on the following factors:
1- The status of the balance of payment of the target country before the imposition of the embargo
2- the relative importance of the targeting countries in the international trade of the target country
3- the possibility of smuggling blockaded goods from and to the target country
4- the availability of alternate markets, especially in neutral countries, for the target country.
Thus, we have assumed that the target country suffers from a deficit in the balance of payment in the pre-embargo stage, that a group of its trade partner countries that represent a significant portion of its trade relations have undertaken a trade embargo on it, that there is no possibility for the smuggling of blockaded goods from and to the target country, and there is no possibility to open new markets for the target country. If, according to the previous assumptions, we can assume that upon the imposition of a trade embargo that consists of an embargo on the exports of the target country only, then the deficit in the balance of payment will increase. But if the embargo is imposed on the imports of this country, then the deficit in the balance of payment will decrease (in the short run, immediately following the imposition). If the embargo is imposed on both the exports and imports of the target country, then the effect on the balance of payment will depend on the rate of the decrease of each in relation to the other. Thus, if the rate of exports of the target country becomes lower than the rate of its imports, the deficit will increase, and vice versa if the rate of imports becomes lower than the rate of exports.
But in light of a more precise and realistic analysis, it is necessary to know whether the trade embargo is being imposed on the necessary imports that do not have international alternatives and that the target country cannot produce internally, or whether it is being imposed on unnecessary goods that have close substitutes, that can be produced internally, or that can be dispensed with without noteworthy economic effects.
If the trade embargo is imposed on imports such as spare parts, primary materials and capital goods that factor into the production of goods manufactured for export, if there is no other country from which the target country can obtain these, and if it cannot produce them internally, then this will lead to a decrease in exports, even if there is no embargo on the latter. If the rate of the decrease in exports is greater than the rate of the decrease in imports, then the deficit in the balance of payment of the target country will increase.
If the embargo is imposed on functional imports that are not vital, or on imports that can be easily obtained from neutral nations without unfair conditions, or that can be easily produced locally, then this in itself will lead to a decrease in the deficit in the balance of payment of the target country, if the rate of the decrease of imports is greater than the rate of the decrease of exports. In other words, this embargo would have a positive effect on the balance of payment of the target country in the short term. The decrease in exports can lead to a decrease in the revenue of the foreign currency, which can in turn lead to a decrease in imports, whether in important capital commodities, spare parts, or unimportant goods.
In the case of smuggling the blockaded goods from and to the target country, the target country may have to buy the blockaded goods at a price that is higher than usual, and higher than its pre-embargo figure. It would also need to sell its blockaded imports at a lower price, due to the international intermediaries who would smuggle these goods. This would also lead to an increase in the balance of payment of the target country, due to the rise in the price of imports and the decrease in the price of exports of the target country.
If there exist alternate markets in which the target country can exchange its blockaded imports and exports for a price that is comparable to the pre-embargo status, then it can overcome the negative effects of the balance of power that result from the imposition of this embargo. This would not occur before the passing of a sufficient amount of time to enable a transition from old to new markets. The effect on the balance of payment in this case would depend on the length of this stage, assuming that the imposed embargo would continue for a period of time that is long enough to allow for this shift and for its results to be apparent on the balance of payment of the target country.
As for the impact of the trade embargo on the international value of the local currency, this depends on the following factors:
1- the pre-embargo condition of the balance of payment in the target country
2- the extent to which the target country has carried out a policy intended to lower international value of its currency in order to increase exports
3- the state of the target country’s balance of payment after the imposition of the trade embargo on it.
Assuming that the target country was suffering from a previous deficit in its balance of payment, and that the value of its national currency is determined by supply and demand, and assuming that the final result of the trade embargo is the increase in the deficit of the balance of payment of the target country, then the rate of decrease of the local currency’s international value will increase. On the other hand, if the final result is the decrease in the deficit of the balance of payment after the imposition of the embargo, then the rate of the decrease of the local currency’s international value will decrease.
IV. the national income, its method of distribution, and its effects on the level of economic luxury
The partial or complete imposition of the economic embargo on imports aims to decrease the country’s national income through weakening international trade. The decrease of exports aims to decrease the numbers of workers (including holders of capital) of such projects, leading to a decrease in internal spending on goods and commodities, so that production of exports and other products would also decrease. This in turn would lead to a decrease in production and revenue in this sector. Thus the initial decrease in exports that result from such an embargo will lead to successive decreases in national revenue.
However, if the trade embargo is imposed on imports only, the situation differs. Assuming that the embargo is imposed on unimportant imports that have local substitutes or that can be produced locally, then the national income of the target country will increase since imports will count in this case as a flow factor (not clear about ‘flow’ – of ‘trade’, ‘imports’?) in the national income of the target country. But if the trade embargo is imposed on capital or primary goods and on spare parts (which do not have local or national alternatives, and which cannot be produced in the target nation), and if the circumstances are used to produce goods that are intended to be used locally or exports, then the net result of the change in the national income of the target country will depend on the following:
1- the effect of the increase in revenue resulting from this initial decrease in imports
2- the effect of the decrease in revenue resulting from the decrease in production of the goods that are based on these imports.
If the first effect is higher than the second, then the result of this on the change in the national revenue of the target country will be positive. If the second is higher than the first, then the result will be negative.
Yet what would be expected is that if an embargo is imposed on the exports of the target country and on its imports of previously mentioned important goods, then the final result on the change in the national revenue of the target country will be negative.
As for the effect of the embargo on the distribution of revenue in the target country, this will depend on the following factors:
1- the flexibility of the production mechanism, and its ability to change the production factors in the various sectors of the target economy
2- the fluidity of wages, and subsequently the role of unions in the target economy.
The analysis will occur in light of the following assumptions:
1- there is no interference on the part of neutral countries
2- Preventions goods smuggling from and to the target country.
3- the production mechanism in the target nation is flexible
4- the production sectors in the target economy are not working under the circumstances of full employment, and the non-trade sectors can absorb the workforce directed to them with facility
5- the unions in the target economy are weak and unable to secure the rights of their members, so that the workers can accept lower wages due to the embargo.
Under these assumptions, we find that the imposition of the trade embargo on the exports of the target country aims to redistribute revenue against the benefit of the producers of export goods. Likewise, the embargo on imports endeavors to redistribute revenue in favor of producers of substitute goods. Furthermore, in accordance with previous assumptions, it strives to redistribute revenue in favor of the employees in some sectors and against those in other sectors. The financial embargo on exports aims to decrease the production of goods for export, assuming that these goods require heavy labor. This thereby harms employees in these sectors and increases unemployment in these and related sectors, or at least decreases their wages and forces them to accept this lower pay. If the embargo is imposed on imports, then it is according to the previous assumptions, so that the target country can move to production in lieu of the imports if possible, leading to increased demand on workers in this sector. Such was the case in the trade embargo that was imposed on South Africa from mid-1985 until 1990-1991 that led to an increase in the demand on workers in the sectors that were producing materials in lieu of previous imports (Shephard, p. 75).
Yet on the other hand, we find an increase in the price of these materials, most of which can be seen as the starting points in the production of local goods, leading to an increase in the prices of these goods in general. As a result, real revenue declines for all workers in different rates. This, in turn, leads to a decrease in spending on unimportant consumer goods and a move towards spending on important goods, thereby affecting their level of economic luxury. Likewise, the inability to import any new products used by those in other nations leads to a decline in the level of economic luxury, as those in the target nation are obliged to accept the harsh economic conditions imposed by the embargo.
The increase in demand on important goods due to their limited quantity in-country leads to an increase in price, resulting in the appearance of a black market for these goods, and thereby once again weakens the distribution situation. This situation creates a poorer class, as well as a richer class composed of black market traders.
If the production mechanism in the target country is not flexible, and there is no possibility for the absorption of unemployed workers from the trade sector to the other sectors in the economy, the effects of the embargo on the target country are greater. In the case of the neutral nations intervening in trade with the target country, the possibility of international alliances with the target country, or the secret collaboration of some countries with the target country, then these emerging effects regarding distribution of income and the luxury level of consumers resulting from the trade embargo will decrease significantly from what is expected in the absence of these venues.
V. The effect on the distribution of resources and on economic growth
If the target nation mainly relies in its exports and imports on a particular group of nations, then the imposition of a trade embargo on it on the part of these nations (please re-check this part of the sentence – not sure it reads correctly) will lead to a decrease in the relative price of exports and an increase in the relative price of imports internally, resulting in a redistribution of resources that, as a whole, would be in favor of non-trade goods and substitute goods produced in lieu of imports. This is based on the following assumptions:
1- The production mechanism for these goods is flexible, and can absorb an increase in production factors from the trade sector
2- The possibility of shifting production factors from the trade goods production sector to the sectors of non-trade and substitute goods.
An example of this is what occurred in Rhodesia during the economic embargo that was imposed upon its tobacco exports by Great Britain (Rhodesia’s main international trade ally) between 1965. Tobacco was one of the most important of Rhodesia’s exports, representing approximately a third of the value of exports. This led to a 47% decrease in the production of tobacco just between 1966 and 1967, resulting in farmers switching to other crops such as corn, wheat, and cotton, all with the encouragement of the government. The embargo on some industrial imports led to a growth in alternative local industries such as the production of train carriages, auto bodies, buses, aluminum sheets, and metalware (Abd al-Qader Attiya, pp. 18-19).
The shift of the target nation from trade production to non-trade and substitute production aims to affect the rate of economic growth in the target country. Generally, the purpose of looking toward the outside is the creation of economic growth in the target country, but in this case it cannot enjoy this due to the embargo. Many studies have proven the importance of looking to the international realm for economic purposes. These studies have concluded the effectiveness of the growth of exports for realizing economic growth. For example, Bela Balassa argues that the policy of encouraging exports leads to an improved capacity in allocating resources according to relative advantages, the benefit from large scale operations, the introduction of technological advances to deal with external competition, and the availability of employment resources to fight unemployment. Likewise, William G. Tyler sees that following a strategy for import substitutions created economic problems that can be seen as burdens and expenses on growth. He clarifies that the spectacular success that the policy of encouraging exports in some countries as well as the spectacular failure for the policy of substitution of imports merits an examination of the role of international trade in realizing economic growth for developing countries. This is what leads to a need to refocus on the advantages of trade for developing countries. An embargo on the exports of the target country aims to lower the rate of export, and thus decreases the long-term ability of the country to compete in the international market, resulting in its loss of global markets and thus its ability for production that is governed by breadth of the market.
On the other hand, the effect of the embargo on imports on the rate of economic growth depends on whether these imports are intermediary or capital goods, and whether they have local or national substitutes that can be imported by non-targeting nations. Many studies have been undertaken to research the relationship between foreign imports and the rate of economic growth, among which are those by Helpman & Grossman, Batiz & Rivera, and Quah & Rauch. These studies concluded that an increase of foreign imports aims to increase the rate of economic growth, based on the assumption that either these foreign imports are of better quality than local ones, or that there are no local equivalents.
For example, Jong-Wha Lee undertook an empirical study of a group of developing countries between the years 1960 and 1985, examining the impact of importing capital goods on the rate of economic growth. He concluded that, assuming that the importing nation has a relative rate of production of consumer goods, its national revenue is decreased, and that it faces a decrease of capital, it can then realize a rate that is higher than that of its economic growth if it imports capital goods from those nations that enjoy a higher national income.
Lee also clarified that the increase in the rate of foreign products to local products for investment is an important factor for economic growth, since their use is relatively cheaper and of higher quality than local capital goods. As a result, any trade distortions, such as limitations on the import of capital goods, would lead to a decrease in the rate of economic growth in the long run. This is because of the economy’s direction towards using local capital goods in a manner that is higher than the efficiency level determined for it.
As a result, if a trade embargo is imposed on the exports of the country, then the purpose of this would be to decrease the rate of economic growth in it for the following reasons:
1- Perhaps the growth of exports would lead to an increase for external demand for the products of the target nation if no embargo is imposed on it
2- An increase in exports could lead to an increase in the revenue in foreign currency, allowing for the increase of intermediary and capital imports, contributing to the growth of its part in the growth of the real gross national product.
3- The growth of exports is due to the increase of production abilities as a result of the adoption of modern technologies, the development of organizations skills and taking advantage of surpluses of volume and other requirements of external competition, resulting in the end in an increase in local production. The trade embargo may lead to the loss of this economic advantage.
4- Perhaps the increase in exports – if no embargo is imposed on it – may lead to a growth in the workforce, resulting in a rise in the growth rate.
The imposition of a trade embargo on the imports of the target nation with regard to foreign capital goods aims to reduce the rate of economic growth in the target country, even if these goods have local alternatives. This is because imported capital goods enjoy a higher level of production than local capital goods.
This entire analysis assumes that the target nation is a developing country with a low income.
We also find another case where a target nation is in a constantly under the threat of war by not meeting the demands of the targeting nations. In attempting to create a sort of stability and security, it moves some of its civil resources into the defense sector. The size of these resources depends on the size of defense spending. In addition to this, this spending on defense aims to crowd out investment spending to ensure the existence of the available foreign funds to import war machinery (from non-targeting nations or through smuggling), that leads to a decrease in the resources available for actual investment. As a result, the rate of economic growth decreases in the target country.
This analytical article concludes that trade embargo has the following effects on the economy of the target nation:
1- A decrease in the size of international trade. But the rate of decrease depends on the relative weight of the targeting nations’ trade within the international trade of the target nation, the existence of nations that are neighbors or allies of the target nation, and the possibility of smuggling goods from and to the target nation.
2- A change in the framework of international trade. This depends on the possibility of finding alternate resources for blockaded imports and exports, the possibility of smuggling the blockaded goods from and to the target nation, the flexibility of the production mechanism in the target nation, and the possibility of moving the production factors within the various sectors in the economy of the target nation.
3- A geographical redistribution of the international trade. This depends on the existence of a new market as an alternate for the targeting nations.
4- A drop in the conditions of international trade. The rate of deterioration depends on the number of targeting nations and their relative weight in the international trade of the target nation, the possibility of finding alternate markets instead of the targeting nations, particularly among neutral nations, and whether the embargo was imposed on imports, exports, or both.
5- An increase in the deficit of the balance of payment. This occurs if the rate of export decrease exceeds the rate of import decrease due to the embargo.
6- A decrease in the external value for the local currency. This occurs if the final effect of the balance of payment in the target nation after the imposition of the embargo is a deficit. The target nation’s local currency is determined according to supply and demand.
7- A decrease in national revenue.
8- A decrease in economic luxury.
9- A local redistribution of resources in favor of non-trade and substitute goods, according to certain factors
10- A decline in the rate of economic growth due to a decrease in exports and imports of spare parts and capital goods, and a reduction in investment, according to certain factors.
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George W. Shepherd Jr. Effective Sanctions on South Africa: The Cutting Edge of Economic Intervention. New York: Westport, 1991.
W. N. Midlicott. The Economic Blockade, Vol. 1. London
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