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Reasons for the Imposition of an Embargo

2695 words (11 pages) Essay in Economics

04/10/17 Economics Reference this

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1. Demonstration of Resolve:

Many powerful countries impose embargoes to re-assert their positions as leaders of the world economy generally or sometimes in a specific field. Their position as the leading exporters/traders/importers of a particular commodity gives them the bargaining power to affect the target country’s imports/balance of trade/exports by publicly forming coercion with other powerful nations to impose a complete ban on its products (as in the case of an embargo). The effects of the embargo is case-specific depending on various factors such as the politico-economic status of the sender country, the amount of trade between the sender and the target country prior to the embargo and the stance of third-world nations on the proposed ban. For example, U.S.A has frequently imposed trade embargoes on several countries in order to prove its hegemony on the international stage.

2. Deterrence:

Sometimes embargoes are imposed to deter the target country from continuing its questionable policies on the domestic or international stage, policies which violate an international rule or contradicts a moral code of conduct. The aim of such embargoes is to raise the costs for the particular industry of the target nation to a level that renders it non-viable. Many a times, embargoes result in losses for the sender country as well, but the point of the ban is not constrained in a profit-loss statement but in the bigger picture of human rights justification. Recent sanctions against use of sports equipment from Sialkot, Pakistan due to the growing incidence of child labour in the stitching industry is an apt example in this case. U.S.A’s grain embargo imposition and the decision to boycott the 1980 Olympics was a direct reaction to USSR’s invasion of Afghanistan.

3. Satisfaction of Domestic Concerns:

An imposition of Embargo in this case is a reactive measure to the growing discontent with the workings of a nation and its direct impact on the sender nation’s public. World Trade Organisations or Government-alliances impose such sanctions to re-affirm their control over the international order. The Helms-Burton sanction against Cuba is an important case in this regard.

Cumulatively an Embargo has a three-fold objective in terms of the message conveyed: it publicly stands against a set of policies endorsed by a particular country, it brings about a sigh of relief on the international stage as public’s interests are given paramount importance and re-asserts their position as guardians of the general socio-political rights of the world.

In the next section we are going to explain the mechanism of imposition of an embargo on the target country and how the world economy stands to lose due to the sanction.

Graphical Analysis of the Effects of an Embargo

Table : Trade Effects due to an Embargo Imposition on Iraq

Source: Thomas Pugel, International Economics, 12th edition, the McGraw-Hill Companies, 2003.

Prior to the imposition of an Embargo, the gap between the domestic supply and demand in Fig. A is provided by the imports from the soon-to-be embargoing nations (Se) and non-embargoing nations (Sn) in Fig. B. As both types of nations currently provide for exports, the supply curve is elastic and cuts Iraq’s import demand curve (Dm) at the point F, called the free trade equilibrium point and the quantity demanded is Qo while the price charge is Po.

After the Embargo imposition, only the non embargoing nations provide for Iraq’s imports. As the burden of imports fall on a reduced number of nations, the export supply curve becomes inelastic, ultimately resulting in the coincidence of the supply curve Sn and Dm at the point E, called the post-embargo equilibrium point. We can see that the quantity demanded now is lesser than the free trade equilibrium output (QePo). Due to the imposition of the Embargo, the embargoing countries lose on amount of trade equivalent to area ‘a’ while Iraq loses on trade worth area ‘b’ and ‘c’. Due to the higher price charged post-embargo, the non-embargoing countries now enjoy a surplus to trade of area ‘b’. Hence the total loss of trade is ‘a+c’.

The effects of the sanction if obviously two-fold on both the sides of the trade: the price of the embargoed products falls domestically as supply rises given the demand. This encourages an expansion in consumer expenditure while the producers face a disincentive to keep manufacturing at the current rate. In Iraq, the consumers face a loss in consumer surplus as the prices charged are now higher on one hand and the quantity provided is lesser on the other. This encourages the producers though, as it acts as a trade-protectionist measure to boost domestic production of the embargoed products in Iraq.

A Note on Financial Embargoes:

Such Embargoes usually consist of cessation of financial aid and assistance to the targeted country by the sender nation. It involves complete stoppage of any kind of functioning of the financial instruments to the targeted country’s government by the sender’s government. It is usually imposed with the objective of applying coercive pressure on the target nation in order to make amendments in its policy. Most notably, it takes the form of curtailing Official Development Assistance (OED) as in the case of Japan when it stopped funds outflow to China as a mark of protest against several incidents: in response to the Tiananmen Square Massacre of 1989, the 1995-1996 stoppage of nuclear testing grants to China.

Asset Freezing:

Asset freezes imply to the complete freezing of whatever the Target nation’s owns in the sender country. It includes property, merchandise, bank and trade accounts etc. In case of such ownership, the assets stand at the peril of the sender’s government for example,

The 1979 U.S.A asset freezes of Iran and Argentinean asset freeze by U.S.A again in 1982. Most notable of these cases is the asset freezing of Al Qaeda and its commander in chief Osama Bin Laden.

Mechanism of an Embargo:

The Embargo is usually imposed with the motive of commanding the target government to change its specific behaviour regarding a policy along the lines of the sender government’s demands. This is done by handicapping the target government (and its influential leaders) of major commodity supply or money inflow or employees. Inefficiency of the target government due to a resource crunch causes domestic discontent and civil wars in more extreme cases. This social disregard for the viability of the government is the main driver for changes in policies that the sender government aims for. Even though such a systematic outplay of market forces is case specific, using the means of domestic chaos and social discontent in order to meet the ends of a political transformation is the application of an Embargo in a capsule.

Factors affecting:

1. Scale of Economics involved:

In usual cases, the size of the sender government is comfortably larger than the target government. According to Hufbauer, Schott, Eliott and Oegg in the 80% of cases, the size of the sender government is about 10 times the size of the target government. Even though of such a high majority of cases, a large size of the economy is not the only prerequisite for an embargo imposition. There have been sufficiently many cases earlier in which smaller countries have successfully brought about changes in the larger countries’ policies through political diplomacy.

One such case here is U.S.A caused Pound-Sterling Crisis which prohibited U.K from accessing IMF loans and the American Dollar Market. Another important case in this regard is the success China received from stopping France, an economy three times its size from selling arms and ammunitions to Taiwan (1990).

2. Trade Linkages:

The trade relations between the sender and the target government prior to the economic sanction/embargo are also an important factor on which the success of the ban pivots. If there is a high frequency of trade between the sender and the target government and the sender government accounts for at least 10% of the target government’s trade, then the success of the ban is somewhat probable. A study says that in those cases which were considered successful, the average sender country accounted for about 30% of external trade with the target government but to say that this is the most important prerequisite is wrong, as cases considered as failures had the sender country accounting for 29% of the target country’s trade on an average.

For example, Turkey successfully banned Italian products in 1989 in order to extradite one of workers of the Kurdish Workers’ Party (KWP’s). Turkey blamed Italy for supporting terrorism in the home country while Italy blamed Turkey of not living up to the expectations of Europe. This sanction was successful even though Turkey accounted for Italy’s 2% of Exports and 1% of Imports.

3. Political Health and the Economic Stability of the Target Nation:

The success or failure of an economic sanction depends on the political and economic health of the target nation prior to the sanction. As the target nations are weaker, characterised by low growth rates and high rates of inflation, an economic sanction is more likely to affect them. Hence, due to the ratchet effect these target nations are more likely to change their policies in wake of such sanctions passed. Stronger regimes are able to withstand these problems by compromising selflessly while weaker regimes give in to the system and are replaced by opposition parties who are more ready to cave in to the sender’s demands. It is very important for target countries to have a multi-faceted growth approach as bilateral trade raises the risk of an economic downturn in wake of such sanctions being passed.

4. Costs of Sanctions to Target:

The target nations, usually the weaker economies can have major adverse impacts due to a sanction. Out of the 114 cases studied in Economic Sanctions Revisited, only 16 are supposed to have suffered losses worth more than 10% of their GDP. Out of the 114 such cases, at least 25% of them had suffered losses more than 2% of the GDP. Even though 2% sounds nominal, it still can have major impact on the nation’s balance of trade, employment opportunities, state revenue, Investment opportunities and FDI.

An important mention here will be the multilateral sanctions imposed on Iraq in the aftermath of the Gulf War. As a result of the Embargo, Iraq lost:

  • 13.6 billion USD in terms of Oil Rents
  • 4.6 billion USD in terms of Exports
  • 620 million USD in terms of cessation of U.S.A Agricultural Credit and Freezing of Iraqi Assets

The same study points out that since 1985, about 50% of the total number of embargoes have caused losses worth at least 5% of the GDP. The intended impact of an embargo is usually diluted due to two reasons:

  • Imposition of a partial Embargo on a limited array of products due to limited interests or fear of international organisations.
  • The Target Country’s ability to circumvent sanctions and sign free trade treaties with partner nations on account of mutual benefit. For example, UNITA’s agreement with Republic of Congo and Zambia for redirection of trade flows.

5. Cost of Sanctions to Sender:

Sender’s cost in case of an embargo is usually a ‘trivial dislocation’ of interests. Due to the large sender-target GDP ratio, the losses incurred to the sender country are seldom magnificent. Some economists argue that the losses incurred in the wake of an embargo should be traded off with the losses incurred due to inaction. Some losses do surely occur on account of the following reasons:

Firstly disruptions in trade flows, investments, support grants and aids cause considerable losses as the sender country is causing trade protectionism due to ban imposition. As a result of limited trade, people in the trade sector lose jobs and security. Secondly, and more importantly market re-penetration costs once the ban has been lifted are humungous. An important case in this regard is the Trade sanction of U.S.A against Vietnam and the breakdown in the aviation deal. Boeing lost a staggering 1.6 billion USD because of the sanction to its arch-rival, the French aircraft engine conglomerate Airbus. Loss of confidence is an important issue once the ban is lifted. The target country is sceptical to further its business trade with the sender, due to the past betrayal. If the political concerns are not met for the sender country, such sanctions end up doing them more harm than to the target country.

Case 1: U.S.A Imposition of Embargo on Cuba:

1. Initial goal of the USA government was to overthrow the Castro regime, by inflicting the government as much trouble as it could. USA wanted to show the world that the socialist way of working couldn’t prosper in the western hemisphere.

2. Post 1970’s, USA’s stance somewhat modified. Their objectives from the Cuban Embargo have been clearly stated in the following words of the Assistant Secretary of Inter-American Affairs:

The Carter Administration has begun an effort to improve trade relations with Cuba, but normalization will take a long time and will depend on many factors, including Cuba’s international behaviour […] The US desires: Improvements in the human rights situation of Cuba; release of political prisoners, thousands of whom have been jailed for years; more responsible international behaviour by Cuba, particularly in Africa; and compensation to US citizens and businesses whose property was taken up by the Cuban Government.”

Terence A. Todman, Assistant Secretary of Inter-American affairs

Date: February 7th, 1978.

3. Since 2000, USA’s goals have been somewhat coagulated. It involves cooperation with the Cuban government on topics of common interest like migration; developing a co-operative developing society; applying pressure on the Cuban government to improve their human rights situation through economic sanctions and forged multi-national alliances.

Reaction of Cuba:

Because of the US embargo, Cuba had to redesign its trade policy in order to nullify its adverse effects. In 1963, an extensive plan for trade relations was laid out with USSR, commonly called the sugar reforms. Moreover, an extensive aid plan by the USSR was enforced.

A report prepared by the CNB (Cuban National Bank) with the objective of presenting to its Paris club creditors revealed that the Cuban government bought sugar at highly subsidized rates from the international market and sold it to USSR at abnormal profits in order to purchase Russian petroleum. A major portion of this petroleum was then resold at higher prices. About 80% of the total petroleum imported was later resold.

In the 1970s Cuba started funding communist regimes in Africa and South America, finally stabilizing its position as a communist force in the world market. These brought about the civil wars in Angola and Ethiopia in the mid 70’s. Cuba’s forward strides in the international markets and its financial stability were soon to be demolished as a result of the USSR disintegration. As the Soviet Republic broke, the Cuban government plunged into Balance of Trade and Current Account deficits. The Castro regime relied heavily on its socialist counterparts and as a result its economic policy took a major thrashing.

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