The shadow of sanctions: reputational risk, financial reintegration, and the political economy of sanctions relief

Abstract

Financial sanctions have become a major component of American foreign policy. Since 2015, the number of blacklisted actors has nearly tripled, coinciding with US financial campaigns against Iran, North Korea, and Russia. This paper centers an under-examined paradox of this proliferation: the complexity of lifting financial sanctions. Indeed, successful sanctions regimes necessitate both sticks (punitive sanctions) and carrots (economic incentives). Yet financial sanctions often limit the economic benefits promised to target states, as banks and other financial institutions risk hefty material and reputational costs if they are to cooperate with previously sanctioned actors. Thus, while financial sanctions are effective at producing negative market reactions against a target, they can be hugely damaging if market actors do not cooperate with the lifting of sanctions. To capture this dynamic, this paper leverages process-tracing to observe financial market reactions to sanctions relief in three key cases—Iran (2010–2015), North Korea (2002–2007), and Libya (1996–2008). It finds that in each case, the presence or absence of US Treasury blacklisting corresponds to the post-sanction willingness of financial actors to extend sanctions relief to targeted states. In doing so, this study identifies “reputational risk” as the primary causal mechanism limiting a target’s reintegration into the global economy.