24 February 2016

The Right Way to Sanction China

February 23, 2016
OVER THE LAST five years, the United States has struggled to influence Chinese behavior. Washington’s responses to Beijing’s increasingly assertive activities—ranging from economic espionage to artificial island construction—have been largely ineffective. Yet U.S. leaders are now considering a new option: economic sanctions. Conventional wisdom holds that the U.S.-Chinese economic relationship is “too big to fail” and that Washington therefore has little economic leverage with Beijing. Indeed, U.S. policymakers should be realistic that extensive sanctions against China would be unwise and infeasible. Nevertheless, certain limited, conduct-based sanctions may be able to shape Chinese behavior at an acceptable cost.

The surprising aspect of the debate in Washington over whether to sanction China is that it took so long to emerge; within the last decade, the United States has sanctioned every one of its major national-security concerns other than China. Iran, Russia, North Korea and terrorist groups have found themselves facing not only U.S. unilateral sanctions, but extensive international sanctions regimes. Acknowledging the need for more effective policy options, President Barack Obama issued an executive order providing the Treasury Department authority to sanction state and nonstate actors—including Chinese entities—engaging in malicious cyber activity. Last year, the administration threatened to impose sanctions on a number of Chinese persons in the lead up to President Xi’s state visit. Likewise, various presidential candidates have suggested that the United States impose sanctions against Chinese agencies or businesses involved in cyber attacks against economic targets.

Yet China is not Russia or Iran, and trying to impose an extensive sanctions regime on Beijing would be both unwise and ultimately ineffective. Given China’s global economic importance—notwithstanding its recent economic troubles—U.S. policymakers would struggle to attract the international support required to implement an extensive sanctions regime in response to cyber attacks or regional coercion. In addition, unlike the Russian or Iranian economies, which are dependent on energy exports, the Chinese economy is highly diversified and would be much more resilient to sanctions. Even if such sanctions could be constructed, China has the economic heft and political influence to hit back and do real damage to both U.S. companies and broader U.S. interests. If Beijing viewed extensive economic sanctions as an effort to undermine the economic basis of the Chinese Communist Party’s rule—particularly in the aftermath of China’s recent economic stumbles—Beijing’s response could be highly escalatory. In short, China’s global importance and its enormous economy inoculate it against the type of extensive sanctions levied on Russia and Iran.

Nevertheless, the United States has a set of more targeted economic options for shaping Chinese behavior. These options would need to be limited and designed to deter or reverse specific destabilizing activities undertaken by Chinese individuals, companies or agencies. While these options are far from perfect, they may provide policymakers better responses than threatening to use military force—or watching idly as China alters the status quo.

STARTING IN THE mid-2000s, the United States began employing highly sophisticated and targeted economic sanctions. Washington found new ways to pressure rogue actors by leveraging the dollar’s importance in the world financial system, private firms’ reputational concerns and the fact that the United States is the hub for many technologies necessary for economic development abroad. The construction of sophisticated sanctions regimes effectively rehabilitated sanctions as an effective tool of foreign policy after they fell out of favor in the late 1990s.

In the case of Iran, the United States used its position as the financial capital of the world—and its largest market—to force foreign companies to abandon their business with the Islamic Republic. The U.S. Treasury Department threatened companies with a choice: either do business in U.S. financial markets (and have access to U.S. dollars for transactional purposes) or do business in Iran. A large number of foreign firms consequently ceased doing business with Iran, exerting economic pressure on the Islamic Republic. This ability to impose biting sanctions was—at least in part—responsible for bringing Iran to the negotiating table and ultimately concluding the nuclear deal.

Similarly, the United States has imposed sophisticated sanctions on Russia that target Moscow’s ability to refinance its massive external debt and prevent its firms from developing key energy resources. These sanctions leverage U.S. asymmetric advantages, such as technological superiority and attractive capital markets. The sanctions prevent U.S. energy companies from providing Russian firms with cutting-edge technologies to develop difficult-to-reach oil resources. U.S. and European Union sanctions also prohibit Western financial firms from dealing in new Russian debt or equity with more than a thirty-day maturity period. This makes it difficult for Russian companies to secure the necessary financing to service the country’s massive debt.

Policymakers have seen the powerful impact of these sanctions and concluded that they can be used to address a wider range of foreign policy issues. As U.S. Treasury official David S. Cohen noted in a 2014 speech, “[f]inancial power has become an essential component of our country’s national security toolkit. That fact may mean that we are called on to use it more frequently and in more complex ways than we have in previous decades.”

Not surprisingly, U.S. policymakers have grown more interested in employing sanctions to counter Chinese activities. White House officials have threatened to sanction perpetrators of cyber attacks. Likewise, policymakers have investigated whether sanctions could blunt China’s increasingly assertive maritime activities. Based on public statements and private discussions, it is clear that the administration is moving closer to employing economic leverage to shape Chinese behavior.

YET EFFECTIVELY using extensive sanctions to deter Chinese economic espionage and maritime assertiveness is likely to prove difficult. First, imposing extensive sanctions would be politically difficult within the United States. Most U.S. policymakers recognize that China’s rise presents many opportunities for the United States. China’s economic dynamism has pulled hundreds of millions out of poverty and energized regional and global economies. Beijing’s growing political influence could help alleviate shared problems such as climate change and nuclear proliferation. China’s increasingly capable military could even cooperate with the United States to conduct humanitarian assistance and disaster relief, noncombatant evacuation and peacekeeping operations abroad.

For these reasons, the Obama administration has attempted to focus its relationship with China on shared interests rather than divergent perspectives. Imposing extensive economic sanctions on China would seriously damage bilateral ties. For example, to authorize sanctions against China for its activities in the South China Sea, U.S. law requires the president declare a national emergency in response to an unusual and extraordinary threat to the United States. While such a declaration is pro forma under most U.S. sanctions programs, declaring that China’s actions pose an extraordinary threat to the United States would be a major political step and appears unlikely during the current administration.

Second, building international support for extensive sanctions would be treacherous, if not impossible, barring a severe Chinese escalation. U.S. efforts to pressure Iran to the negotiating table were successful because they were international. Similarly, U.S. sanctions on Russia have caused significant economic pain because they are multilateral. In both cases, European and Asian allies and partners coordinated with the United States to bring economic pressure to bear. Without this cooperation, both Iran and Russia would have been able to blunt the sanctions. Given China’s large economy and political importance, many of these countries would be unwilling to impose sanctions under anything but the most extreme circumstances.

Third, the Chinese economy is inherently more resilient than smaller or more sector-specific economies like those of Russia and Iran. China’s economic weight alone means that extensive sanctions would not only take a bite out of Chinese growth, but would damage the global economy. Moreover, China plays a critical role in the international trading system as a manufacturer of finished products. Finding alternative manufacturing centers would take time. Unlike the energy markets, which were able to respond relatively quickly to sanctions on Russia and Iran, trade with China is inherently less flexible. In short, China’s size and market position insures it against the exercise of U.S. asymmetric economic leverage.

Fourth, China’s response to sanctions could be very damaging. Unlike Russia or Iran, China could severely harm U.S. economic interests and those of U.S. allies and partners, both in the region and around the world. Despite the repeated use of sanctions since the end of the Cold War, the United States has never imposed them on a country with substantial economic response options. Beijing, on the other hand, could adopt both symmetric and asymmetric responses. China could impose sanctions on U.S. companies, or make it significantly more difficult for certain U.S. companies to do business in China. Numerous U.S. businesses have already encountered political challenges to operating in China, which have caused some, like Google, to withdraw from mainland China despite its huge market. Similarly, in recent months, China has threatened to impose so-called secondary sanctions on U.S. defense manufacturers that provide arms to Taiwan as part of a newly announced U.S. package, cutting these companies off from Chinese markets. Beijing could do the same to U.S. allies’ and partners’ businesses, and levy additional economic measures, such as restricting key exports to or imports from those countries. Such responses accord with China’s traditional use of subtler forms of economic statecraft.

U.S. sanctions would also risk retaliation through horizontal escalation in other domains. China might adopt measures to undermine U.S. centrality in the global economic system, such as efforts to undermine confidence in the U.S. financial system or to more rapidly shift away from dollar-based trade and investment. Alternatively, China could increase the pace of land reclamation and militarization in the South China Sea or more frequently confront U.S. ships and aircraft operating in international waters and airspace. China could also become less cooperative on a host of other issues that are important to U.S. interests, from climate change to the nuclear deal with Iran.

ERECTING EXTENSIVE sanctions against China would be unwise and infeasible, but more limited sanctions may shape Chinese behavior with fewer negative effects. In particular, measures designed to deter internationally recognized “bad conduct” by Chinese individuals, companies and agencies—particularly those who commit economic espionage—could be effective. On the other hand, sanctions are likely to be less useful in maritime disputes involving ambiguous territorial claims.

When considering specific sanctions, policymakers should ask five questions. First, do existing authorities provide mechanisms for sanctioning the actors responsible? Second, would sanctions be sufficiently powerful to compel these or future actors to change their behavior? Third, would foreign partners cooperate in levying such sanctions? Fourth, how might the adversary respond and how damaging would these responses be? Fifth and finally, would the imposition of sanctions reinforce or undermine norms of good conduct and strengthen or weaken the long-term viability of the overall U.S. sanctions position? The answers to these questions vary depending on the specific sanctions under consideration:

Countering Chinese economic espionage: The attractiveness of carefully targeted sanctions is most clear in the cyber realm. The United States has already raised concerns about cyber espionage against private corporations and the Department of Justice has indicted five Chinese military hackers. The Federal Bureau of Investigation reported that cyber espionage increased by 50 percent in 2015. U.S. officials have pointed the finger at China for some of the most egregious attacks—including the massive hack of the Office of Personnel Management in which Chinese persons stole security-clearance information for over twenty million U.S. citizens. Although President Obama and President Xi announced a “common understanding” that neither government would engage in cyber economic espionage, early reports suggest that government-sponsored Chinese hackers have continued what has been called “the greatest transfer of wealth in history.”

Chinese actors engaged in theft of U.S. intellectual property could be designated under existing U.S. authorities, which would effectively prevent them from doing business in U.S. markets or with U.S. companies. Although this punishment might not force domestically focused Chinese companies to change their behavior, it would send a signal to companies with a U.S. presence that engaging in such activity entails significant risks. Such sanctions could be coordinated with efforts to protect trade secrets to demonstrate the seriousness of U.S. concern to Chinese leaders.

From an international perspective, targeted sanctions might prove attractive to other developed economies suffering from persistent Chinese cyber espionage. The economic damage from the sanctions themselves would be limited in developed countries because Chinese firms stealing intellectual property are hampering growth abroad. In addition, the risk of China implementing its own sanctions on economic espionage would be limited because U.S. law already prohibits this type of economic espionage. Moreover, Chinese groups already conduct sustained cyber attacks on U.S. businesses, so sanctioning a number of these actors might not substantially change the frequency or fierceness of intrusions. There is no doubt that China could take action in other domains, but targeted designations could set U.S. red lines and make clear that the United States and its partners are willing to take a more forceful stance to uphold norms of good conduct in cyberspace.

Countering Chinese economic coercion in maritime disputes: Another potential area for targeted sanctions is in response to Chinese economic coercion in disputed maritime zones. Beijing has sought to consolidate control of the South China Sea by constructing a “Great Wall of Sand” on disputed maritime features. In addition, China has used coast guard and fisheries vessels to push other claimants out of disputed waters in the East and South China Seas. Beijing has also used its own economic statecraft to limit tropical fruit imports from the Philippines and rare-earth exports to Japan in response to clashes over maritime claims. Finally, questions are mounting about whether Chinese investments, from the port of Darwin in Australia to the island of Saipan in the Commonwealth of the Northern Mariana Islands, might be intended to alter U.S., ally or partner behavior in peacetime, or change military options in a conflict.

Countermeasures have already been applied in several of these cases. For example, the United States, the European Union, and Japan brought and won a case at the World Trade Organization arguing that China had applied export quotas on rare-earth elements in 2010. Meanwhile, the United States has criticized construction on disputed features and operated platforms within twelve nautical miles of some features. Nevertheless, the pace of construction has accelerated in recent months.

At the moment, U.S. officials do not have existing mechanisms to sanction businesses engaged in bad behavior in maritime disputes. Yet, there are several tempting targets for sanctions, most notably China Communications Construction Company Dredging (CCCCG), which conducted dredging at disputed South China Sea features, and China National Petroleum Corporation (CNPC), which moved an oil rig into waters disputed with Vietnam. Further, China has reportedly invited private or semiprivate firms to invest in building the infrastructure on a number of these reclaimed islands. U.S. officials could obtain the legal authority necessary to sanction CCCCG , CNPC or other Chinese entities if the president were to declare a national emergency related to China’s destabilizing actions in the region. This would no doubt be seen as a significant escalation.

Nevertheless, sanctioning entities involved in construction or development in disputed areas could alter their calculus, disincentive destabilizing conduct and thereby decrease tensions in the long-term. Detailed understandings of these firms and their domestic political connections within China would be required, but there are reasons to believe that they might be responsive to outside pressure. For example, CCCCG and CNPC are already listed on the Shanghai Stock Exchange, and CCCCG was reportedly planning a new listing on the Hong Kong Stock Exchange. However, CCCCG has delayed its initial public offering in Hong Kong, allegedly because the Exchange asked a number of questions about dredging activities in the South China Sea. CCCCG or CNPC could find their business partnerships damaged and their ability to deal in U.S. dollars curtailed if they were added to the Office of Foreign Assets Control’s Specially Designated Nationals List. This would in turn harm the companies’ value, affect their ability to raise funds and impact their operations. Such efforts might not stop Chinese coercion in the South China Sea, but they would impose a cost both on the Chinese companies involved and on Beijing’s reputation.

However, even if U.S. targeted sanctions were effective in pressuring specific firms to change their behavior in the South China Sea, some major obstacles would remain. First, other countries in the region have previously engaged in similar activities, so it might be difficult to build robust international support to impose truly biting sanctions. Additionally, the United States would have to decide whether to impose similar sanctions on other countries’ firms operating in disputed waters. Moreover, Chinese leaders could offset private losses incurred by U.S. sanctions, which would limit their effectiveness. Furthermore, China could respond asymmetrically by escalating in other domains in which Beijing has more leverage.

BEIJING’S INCREASINGLY assertive behavior is triggering a global debate about potential responses. Unfortunately, diplomatic and even military measures have thus far appeared largely ineffective at deterring destabilizing Chinese activities in cyberspace and maritime zones. Washington’s growing debate about applying other foreign-policy tools, including sanctions, is therefore inevitable. Indeed, the mere discussion of sanctions could itself prove a valuable deterrent.

In considering sanctions on Chinese individuals and entities, American policymakers should be realistic about their likely effectiveness. Applying an extensive international sanctions regime on China would be unwise and infeasible, so sanctions would have to be more limited and targeted. Moreover, unlike the recent sanctions on Russia and Iran, which were relatively low risk, sanctioning China carries substantial risk of damaging political and economic blowback. Nevertheless, a carefully calibrated economic response may be effective in altering Chinese behavior, and targeted sanctions on certain Chinese actors would demonstrate to Beijing that Washington is serious about upholding international rules and norms, and that is willing to accept some risk to do so. Beijing is already using economic leverage to change the behavior of U.S. national security and business leaders, as well as that of U.S. allies and partners. Washington shouldn’t be afraid to respond in kind.

Zack Cooper is a fellow at the Center for Strategic and International Studies, a doctoral candidate at Princeton University, and a member of the Center for Sanctions and Illicit Finance board of advisors. Eric Lorber is a senior associate at the Financial Integrity Network, an adjunct fellow at the Center for a New American Security, and a senior advisor at the Center for Sanctions and Illicit Finance.

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