The Economics of Sanctions: Half Measures, Tit-for-Tat Strategies, and Why North Korea is Not Iran


On September 9th, 2016, North Korea conducted what South Korean and Japanese estimates called its biggest nuclear test to date, with a nuclear yield equivalent to approximately 10 kilotons of TNT (the bomb dropped by the U.S. on Hiroshima had a yield of about 15 kilotons). The international community, including the United States, was quick to condemn the test, and calls for new rounds of sanctions came immediately, almost reflexively, and as if it was understood exactly what these calls were requesting. The actual mechanics of sanctions, however, are often hidden behind catchphrases such as “snap back,” “tough,” “tightening,”or “loosening.” While these phrases give one a general idea as to what a sanction is and how it works, an explanation of the actual workings of any given set of sanctions would certainly go further in explaining their severity and meaning.

The term “economic sanctions” refers to the deliberate withdrawal of economic activity that, in the absence of the sanctions, would have probably occurred. The intent, essentially, is to change policy via the punishment of an individual or group. However, the effectiveness of sanctions in achieving their goals has not received unanimous support following the Second World War, and it is not clear whether their success rate should be considered anything beyond marginal.

However, despite their dubious track record, one should not expect the use of sanctions to cease for the foreseeable future, as the enforcement of economic sanctions carries political benefits for powerful world leaders. Retaliating against a perceived wrong with sanctions offers displeased leaders an option that is more coercive than a one-off statement of protest, but less antagonistic than direct military action. Playing this middle ground is domestically popular, and allows a country to convincingly declare its displeasure with a given government or set of individuals without getting their military’s boots dirty.

As a way of modeling the process of sanctions, one can think of the threat of sanctions as a game played between two countries; the sender and the target. Consider the following, where the numbers to the left of each comma refer to the payoffs realized by the sending country at a given outcome, and numbers on the right refer to the payoffs of the target country at the same outcome. For example, at the outcome in the top left where each country cooperates (C,C), the sending country receives a payoff of 5, and the target country a payoff of 1. Of course, the exact numbers of 5 and 1 are not tied to any specific real world measurement, but rather just show that both parties prefer to be in the cooperative stage than in, say, the punishment stage (C,D) in the bottom right.screen-shot-2016-10-11-at-3-33-23-pm

If this were a one shot game, we would expect a result akin to the prisoner’s dilemma, as the target of sanctions would benefit more by defecting, regardless of the strategy of the sender. Knowing this, the sender will choose a punitive strategy to receive a payoff of 0 instead of cooperating for a payoff of -1. However, assuming multiple iterations of the game, both the sender and target country would seek to maximize their payout over an indefinite time horizon, rather than just grabbing as much as they can in one shot. This requires both players to consider the effect that their actions today have on payouts in the future when evaluating the costs and benefits of a given action.

If the sender’s threat of indefinite punitive action in response to deviation is credible (and in this case it is, as the payout of punitive action is preferable to continued cooperation, so long as the target country continues to defect), and the costs that this punitive action inflicts upon the target country will be greater over an indefinite time horizon than the benefits from deviating once, then it is not in the interest of the target country to defect. Given the payoffs in the game above, so long as the game is played more than 3 times after the target country’s deviation, it is not in the interest of the target country to deviate.

This strategy of cooperating until the other player defects is referred to as a “tit-for-tat” strategy, named after the sender’s strategy of only punishing the target when they deviate from the status quo. Economic sanctions are a “tit-for-tat” game between a (usually more powerful) sender country and a target country, where the sender threatens to punish the target via two principal methods: upsetting the target’s trade balance and impeding the target’s financial infrastructure. Upsetting the target’s trade balance is perhaps the more straightforward example, given that this strategy simply aims to either limit the target’s exports or impede its ability to import certain resources. In so doing, the sender attempts to deny the target either the raw materials or tax revenue that it otherwise would have received, thus raising the costs of the target’s disliked policy. In theory, trade sanctions will work if these costs outweigh the benefits of the target’s disliked policy.

However, this type of sanction requires a limited market for the goods that the sender wishes to restrict. If other countries are willing to buy the target’s exports, or if the sender does not own a significant market share of the good that it wishes to keep the target from importing, then the effectiveness of these sanctions will be limited. Additionally, the coercive power of trade sanctions is inversely related to the price of the good the sender is restricting. If the price falls by half its original value six months after the sender country begins sanctions, the target may replenish their original supply at half cost, severely limiting the coercive influence of the sanction. Similarly, if the price of the target’s export rises significantly during sanctions, the target will better be able to accommodate the sanctions.

Impeding the target’s financial infrastructure however, presents a more flexible sanctioning strategy. Financial sanctions generally involve either the freezing of assets of particular individuals involved in the sanction-triggering activity, or the termination of subsidies from the sender previously sent to the target country. Financial sanctions are more difficult for the target to evade, particularly if the target country is embroiled in political or economic instability, or for some other reason may find it difficult to establish new lines of credit. Additionally, deploying financial sanctions allows the sender to better target particular individuals who are either involved in the action that triggered the sanctions or who have a direct ability to address the action, such as politicians and business elites.

Sanctions enforced as a punitive response to the development of nuclear weapons function the same way, as the sanctions aim to raise the overall costs of pursuing the development of nuclear weapons above the overall benefits that that country would receive if they did develop nuclear weapons, all while minimizing the effect of those sanctions on third parties and the economy of the sender country. In game theoretic terms, the target deviates by pursuing nuclear weapons, and the sender country looks to punish this deviation harshly enough to keep the target from choosing the deviation strategy now or in the future. It is important to note that there are certainly non-economic benefits at play in these scenarios such political prestige or regional hegemony, but the punishment strategy of economic sanctions looks to raise the economic costs of the deviation high enough to override whatever benefits might come from an active pursual of nuclear weapons.

Contemporary U.S.-Iranian relations represent a high profile, and tentatively successful example of economic sanctions being used to punish the pursual of nuclear technology. The United States assumed the role of the sender country after then-President Ahmadinejad chose a strategy of deviation by lifting the suspension of Iran’s uranium enrichment program. The U.S. punishment came in two waves, one in 2005 with Executive Order 13382, which froze the assets of individuals connected with Iran’s nuclear program that were held in the U.S., and one in 2010 with the passage of the Comprehensive Iran Sanctions, Accountability and Divestment Act (CISADA), which further targeted individuals connected with the nuclear program, but also limited US reception of some of Iran’s key exports. After 2010, the U.S.’s sanctions targeted both the financial and trade sectors, draining the pockets of Iranian elite, and seeking to diminish Iranian exports of goods like oil, pistachios, and rugs. While effective due to the close ties the Iranian economy had to the sanctioned goods, the newly limited access to the U.S. market hurt third-party Iranians as well as those involved with the uranium enrichment program.

Nevertheless, despite the collateral damage of CISADA’s trade sanctions, it would be difficult to argue that they did not help to bring about the correction that the U.S. demanded, as the current President Rouhani’s victory in 2013 and positive reception to news of the lifting of sanctions in 2015 indicate a displeasure with the Ahmadinejad administration’s continued pursual of nuclear weapons in spite of the effects of the sanctions. Though perhaps imperfect, the U.S. eventually got the deal they were looking for. For its part, Iran has begun to reintroduce itself to world markets to the tune of a forecasted 5 percent overall GDP growth in 2016, despite the low worldwide price of oil. In game theoretic terms, the game has returned to an equilibrium of cooperation, with both players are receiving nonzero payoffs greater than in the punishment equilibrium.

However, all is not well with the rest of the world. Like Iran, the U.S. (along with much of the international community) has targeted North Korea with both financial and trade-focused sanctions. The assets of North Korean elites held abroad have been frozen over again and again, and the “direct or indirect” importation into the United States of any North Korean goods is prohibited as of President Obama’s Executive Order 13570 in 2011. However, while the U.S. and the international community have found new financial holdings to freeze and trade restrictions to impose time after time, North Korean officials have not shown any sign of relenting.

Of course, major differences exist between the domestic atmospheres of Iran and North Korea that may play a role in the international community’s inability to correct the deviation of the latter in the same way they have the former. Most importantly, Iran holds presidential elections every 4 years, where the public may voice their displeasure at the current government’s nuclear ambitions and remove them from office, replacing them with someone who opposes nuclear capabilities in favor of economic growth and a better reputation among its peers. North Korea, of course, does not have this luxury, and, short of a coup, Kim Jong-Un and his nuclear ambitions are here to stay so long as he wants them to. Additionally, the Iranian government is hurt more by trade-based sanctions than North Korea, as the Iranian government cannot function via black and grey markets as efficiently as Kim Jong-Un’s regime has proven to be able to.

A key difference, however, is that Iran can feasibly become a world player at some point down the road. As of right now, Iran controls the 4th largest reserve of oil in the world, is located in an enviable geopolitical location, and has taken advantage of the chaos of the region since the fall of Saddam Hussein to extend its influence. For many, a far-reaching imagination is not necessary to see Iran’s future as a serious player on the global stage at some point in the foreseeable future. By continuing its nuclear program, Iran jeopardized this capability by becoming a target for sanctions from the international community, contributing to miniscule or negative economic growth. In the end, the overall benefits of a return to the cooperative equilibrium were obvious, as this equilibrium better suited an Iran who wished to realize its international potential.

Given its limited land area, limited natural resources, and its lack of technological development compared to its peers, North Korea does not have a realistic chance to realize a similar level of global or regional influence. In fact, given the permanent nature of the regime and its apparent willingness to operate on the periphery of the world stage, financial or trade-based sanctions may offer very little additional costs for the North Korean government. In fact, fostering a scenario in which the whole world works against North Korea may serve Kim Jong-Un’s agenda quite well, substantiating his claims that the Western world is conspiring against North Korea. While it is tempting to simply “impose sanctions” on North Korea as punishment for their nuclear ambitions and play the middle ground between a statement of protest and military action, a closer look into what those sanctions would actually entail offers a bleak picture of their effectiveness. Granted, dealing with Pyongyang is a difficult task with no obvious answers, but instead of reflexively calling for another round of sanctions in response to the next successful nuclear test, one should offer a clear and comprehensive understanding of the truly unique situation that one finds in North Korea, and an explanation as to how exactly the next round of sanctions will stop or slow the development of a nuclear North Korea.