Release or Repress? The Effects of Economic Sanctions on Capital Account Openness

Despite the frequent use of economic sanctions by states, there are insufficient analyses of the collateral effects of these measures on target states. Under the sanctions, targeted leaders who pursue the longevity of their regimes adjust domestic policies to mitigate the costs associated with sanctions. Specifically, this article analyzes the effects of sanctions on capital account liberalization in target states. Economic sanctions trigger changes in the capital account openness of target states. However, the direction of the reform is dependent on the political institutions in target states, which characterize the behavioral incentive structure of the leaders. Specifically, economic sanctions lower capital account openness, albeit only in autocracies. Democracies, which are sensitive to the benefits of capital account openness, are less likely to tighten the restrictions. Instead, they are likely to open their markets. I employ the two-way fixed approach to test my argument, using time-series cross-sectional data spanning 145 countries for the period 1965–2005. In this regard, I find evidence in favor of my argument, with the findings suggesting the indirect impact of economic sanctions on target states' financial policies on which the decisions are primarily driven by the political incentives of the targeted leaders.