Economic coercion: how can we reduce our vulnerability?

Lithuania is a small country in the Baltics that is not often in international headlines. When it is, Lithuania usually plays a minor role in complex, ongoing tensions between, for example, Russia and NATO over the fate of Ukraine, or the military pressure that Russia is exerting against NATO’s eastern member states more generally. Yet over the past few months Lithuania has consistently made the front page because of the threats to its economic, rather than military, security, and this time from a different source: China.

Last autumn, Lithuania granted Taiwan permission to open a diplomatic and trade mission in Vilnius. Taiwan’s national status was effectively recognised when its name appeared on the Vilnius office door plate, rather than the capital city of Taipei that Beijing insists on, and China reacted with ferocity. Beijing froze its trade with Lithuania and decertified Lithuanian imports by denying them licences. It cancelled Chinese investments in Lithuania and put pressure on multinational companies worldwide to stop trading with the country. Lithuania responded to this bullying by cancelling a €62.5mn bridge construction project with the Spanish company, Puentes y Calzadas Infraestructuras, which is owned by China’s Bridge and Road Corporation. Vilnius set up a fund of €130mn to help local companies hit hard by the loss of access to the Chinese market, and Taiwan – which needs to keep the dwindling number of countries across the globe that either recognise it or maintain diplomatic relations with it – has offered Vilnius €200mn to develop more bilateral trade with Taipei.

Vilnius has also reached out to the European Union for political solidarity and financial help in standing up to Beijing. It is seeking permission from the European Commission to use part of its €2.2bn COVID-19 recovery NextGenerationEU grant to help its companies. The Commissioner for Competition, Margrethe Vestager, has told Vilnius that she will examine the state aid that Lithuania wishes to bestow on its companies to compensate for the loss of exports to China and ensure it is compatible with EU competition rules.

Relations between Lithuania and China have long been strained as Lithuania was the first country in central and eastern Europe to drop out of the 17+1 China-CEEC forum in which Beijing meets annually with the countries of this region. Vilnius, like many other capitals in NATO and the EU, was becoming worried about the region’s growing dependency on Chinese investments in infrastructure, ports, energy and telecommunications, particularly under China’s Belt and Road Initiative. These concerns were highlighted when Montenegro got itself into massive debt after accepting Chinese money for a motorway project and had to turn to the EU, the European Investment Bank and the IMF for a bailout. Serbia’s growing involvement with China in trade, telecommunications, infrastructure investment, medical supplies, nuclear energy and more recently military technology and weapons sales also raised fears that China will use these ties to gain increasing geopolitical influence in the Western Balkans and eastern Europe. Yet as the case of Lithuania demonstrates, untangling from the Chinese Hydra, once it consolidates its grip, can be painful.

Beijing reacts disproportionately and is ready to escalate dramatically, calculating that it can bear the economic pain, at least in the short term, better than the target country. Even the president of plucky Lithuania was soon asking publicly if the government’s decision to open the Taiwan office was a wise one.

Lithuania is but the latest in a series of examples of China’s use of economic statecraft or coercion to pressure countries to make either economic or political concessions. Observers point to the bans on Australian beef and wine imports after Australian Prime Minister Scott Morrison called on Beijing to facilitate an international enquiry into the origins of the COVID-19 outbreak. Another example is the way that Beijing clamped down domestically on South Korean tourism and discouraged its own citizens from travelling to South Korea after the latter accepted a United States’ request to deploy Terminal High Altitude Area Defense (THAAD) anti-missile systems on its territory as a defence measure vis-à-vis North Korea. Clearly Beijing viewed THAAD as a counter to its ballistic missile force as well.

Of course, this is not the first time this type of inter-state coercion has happened in recent times. During the Trump administration, the US called the EU a threat to its national security and was constantly brandishing the prospect of higher tariffs or reductions in EU car imports to force concessions from the EU over steel, aluminium or aircraft subsidies. Trump also repeatedly criticised Germany’s partnership with Russia to build the Nord Stream 2 gas pipeline, which it saw as providing Moscow with abundant gas revenues to fund its defence budget and hybrid war activities. The US repeatedly threatened Berlin and the holding company, Nord Stream 2 AG, with sanctions if the pipeline went ahead. Trump also used the threat of punitive tariffs against China during the Phase One Washington-Beijing trade negotiations to force China to buy high volumes of US soybeans. The former US president calculated that these immediate purchases would increase his support among American farmers during the then upcoming presidential elections.

Readers of this article will have no trouble thinking of other examples of the link between economics and politics. Yet often these trade disputes are referred to WTO panels for arbitration, something which has long been the case with the EU-US disputes over aircraft and steel, or Washington’s disputes with China over the protection of investments and intellectual property. Moreover, the big trading block and nations generally attempt to negotiate on their differences and reach compromises. They give each other warning of retaliatory trade measures and offer a legal basis through parliamentary processes first. What is different about Beijing’s use of coercive economic statecraft is that it is based on political rather than economic disagreements.

Chinese retaliation is sudden and without negotiation or prior warning. It is also a gross overreaction, as exemplified by China’s sanctions against the European Parliament and the EU’s Political and Security Committee following the rather mild EU sanctions against four Chinese officials and one state entity implicated in the forced labour of the Uighurs. Another factor is not only Beijing’s pressure on the companies of the country concerned, but its efforts to rope other international actors into what should be a bilateral dispute. China achieves this by pressuring other countries and companies to comply with its boycotts. The end result is that other countries are deterred from showing solidarity with the targeted country, much to China’s satisfaction.

As a result of China’s economic assertiveness, Western policymakers and parliaments are increasingly focused on anti-coercion instruments and efforts to develop a toolbox of measures that can both deter Beijing from economic bullying as well as send a coordinated signal that if China persists in a coercive manner, it will face significant costs. At the same time, Western countries are waking up to how their dependency on certain Chinese goods, services, resources and technologies has put them in a vulnerable position – similar to Russia’s use of gas supplies, via Gazprom, to exert pressure on Europe during the current Ukraine crisis. The race is on to formulate a balance between deterrence by denial and deterrence by retaliation in Western policy vis-à-vis China.

The US Congress is a good first place to look. Coming from opposite sides of the aisle, US Representatives Ami Bera and Ann Wagner have co-sponsored legislation in Congress to counter what they see as China’s use of economic coercion measures to gain political and diplomatic leverage over its trading partners. This is a bipartisan initiative where Republicans and Democrats are like-minded and willing to work together. Supporters of the legislation share the view that Beijing uses both official coercion measures, such as denial of market access and import licences, and also unofficial ‘off book’ measures, such as encouraging Chinese consumers to boycott foreign countries or products. These tactics have been used to force many American companies and associations to distance themselves from criticism of Beijing uttered by their senior executives whether regarding Hong Kong, the Uighurs or Taiwan. The US National Basketball Association recently felt the full heat of the potential massive loss of revenue from Beijing’s threat to ban the showing of its games on Chinese TV networks. Beijing has an expansive toolkit to pressure small- and medium-sized countries that depend more on China than it depends on them. Consequently it can stay the course much longer.

Bera and Wagner’s bipartisan bill would require the US administration to set up an inter-agency task force under the National Security Council to conduct a three-year study into China’s economic coercion activities. It further requests the administration to identify best practices and tools for how the US should respond by studying the experiences of America’s allies and partners in dealing with Chinese economic coercion. The response options could include: joint pressure with allies, such as with the EU in the Trade and Technology Council; harmonising legal regimes with allies to facilitate common responses; and economic wargaming with allies to test the cost dynamics of specific retaliation steps, such as higher tariffs or technology and component transfer bans. Other tools identified in the draft legislation are more familiar: sanctions, export controls and technology blacklists, foreign direct investment screening, direct assistance to victims and political statements. US Congressional leaders also stress the need for WTO reform so that the organisation could take up economic coercion in its dispute resolution panels. The proposed anti-coercion bill would either be a stand-alone piece of legislation or could be appended to another bill such as a future National Defense Authorization Act.

The proposed anti-coercion act is modelled on the EU’s current anti-coercion instrument, even though the US Congress recognises that part of the inspiration for the EU’s instrument is the economic coercion that the Trump administration threatened to impose on the EU, embracing not only the cars and steel already referred to but also the denial to the EU of medical supplies manufactured in the US by European companies under the US Defense Production Act. The EU’s anti-coercion instrument is currently being discussed in the trialogue between the EU Council of Ministers, Commission and European Parliament. In many respects it goes beyond the similar proposed US legislation in that it embraces non-bullying forms of economic malpractice, such as the use of forced labour, products violating environmental standards, dumping of subsidised state industry products and aggressive tactics in government procurement contracts.

China has undoubtedly brought Washington and Brussels closer together. Few EU officials speak today of the EU as a third force, equidistant between Washington and Beijing and asserting its profound differences with both the American and Chinese models, which was the talk of Brussels during the years of the Trump administration. US Congressional leaders may not have been happy about the Comprehensive Agreement on Investment (CAI) that the EU negotiated with Beijing, but they have certainly supported the blocking of its approval by the European Parliament after China imposed sanctions on MEPs and EU institutions. Congress has also been reaching out to Canada, Australia and even India – the latter because some members of Congress detect a new Sino-scepticism in the wake of Indian and Chinese troops clashing in the Himalayas.

One big unresolved issue, however, is how to get US companies and the private sector – which is heavily involved in business with China – onboard to support and help implement US anti-coercion legislation, especially if it involves decisions on freezing investments, losing market access and limiting on technology transfer. The EU has heard similar reservations from its own businesses and industry associations which fear being the losers of trade disputes between Brussels and Beijing provoked by the activation of these anti-coercion instruments.

The proposed US anti-coercion act is also part of a package of US bills designed to respond to different aspects of China’s economic statecraft. The act has its counterparts in the EU and other Western countries as well. There is the CHIPS Act, designed to repatriate microprocessor production to the US and to put the US back in the lead by increasing government investment in research and development. Taiwan’s TSMC has already agreed to open two production plants in the US. The US measure has its corollary in a European Chips Act that the European Commissioner for the Internal Market, Thierry Breton, is currently developing as part of the EU’s strategic autonomy. There has also been the EAGLE Act or Uyghur Forced Labor Prevention Act to halt US companies from importing or using components and products from China made by forced labour, such as solar panels. Congress has also been debating a Taiwan Peace and Stability Act whereby the US would give Taipei more diplomatic support, economic investment and trade facilitation to resist embargoes or economic pressures from China. The most recent addition, however, to this legislative palette concerns rare earths.

This is in the form of an act called ‘Restoring Essential Energy and Security Holdings Onshore for Rare Earths’ (REEShore) which is now on the floor of the US Senate. It is designed to reduce US dependency on rare earths and has been introduced by Senators Tom Cotton and Mark Kelly. It is again a bipartisan initiative where there is likely to be broad support among both Republicans and Democrats. The proposed bill would force US defence contractors to stop buying Chinese rare earths by 2026, although US companies could ask the Pentagon for waivers to cover transitional periods or exceptional circumstances. The bill would also require the Pentagon to establish a national stockpile of the 17 key rare earths that are critical for microprocessors, mobile phones and batteries, as well as other electronic components. Moreover, it calls on the US government to examine modalities to restart the domestic production of rare earths. Currently the US has only one active rare earths mine, which is operated by the US company, MP Materials Cooperation, in Utah’s Rocky Mountains. The other plants were closed for commercial reasons or due to environmental concerns, as rare earths production is highly polluting and consumes large quantities of water. As a result, the bill asks the US government to develop mining technologies that can make rare earths production greener. China currently produces 90% of global rare earths supplies. The bill would also oblige US defence contractors to report to the Pentagon on the sources of rare earths used in military equipment.

Of course, there is the irony here that the US would need to increase its imports of rare earths from China significantly in the short term in order to constitute its national stockpile. The bill in its current form also offers no financial support to US defence contractors as they try to locate alternative sources of supply, for instance from Australia where the Lynas Rare Earths Ltd company is planning to increase domestic production. Finally, the bill would require the US Trade Representative to investigate whether China is distorting the rare earths market and advise on whether existing US sanctions on China are an adequate response or recommend new measures, if needed. As with the proposed anti-coercion act, the rare earths legislation could be a stand-alone bill or folded into another piece of legislation. It should be emphasised, however, that the restrictions on the use of rare earths sourced from China only apply to weapons and not to other US military equipment and supplies.

Yet counter-sanctions and anti-coercion instruments can only be part of an effective strategy to fight back against China’s economic statecraft and to reduce Western dependency on China and vulnerability to its fits of geopolitical anger. Just like the EU, the US has to be active and visible on the world stage, offering a positive vision to its partners in the Indo-Pacific. Simply imposing more restrictions and sanctions on China to counter unfair practices and the political manipulation of trade, or to force Beijing to accept a level playing field, is not sufficient. The West has to offer an alternative path to trade, investment, economic growth and integration into global markets.

This is why it is helpful that at his first summit with Japanese Prime Minister Fumio Kishida last week, US President Biden announced a new US initiative for an Indo-Pacific economic framework which Kishida promised to help develop. The US Congress has also voiced its support for the Biden administration’s other proposal for an Indo-Pacific digital trade agreement. This would be more palatable to Congress than US participation in more comprehensive Indo-Pacific trade agreements given protectionist sentiments in Congress.

Digital is also the area where the US feels the challenge of China most acutely in terms of products, the use of AI and algorithms, as well as standards and the need to push back by promoting its own technologies and standards on international markets. The US has been slow in the area of digital. For instance, AT&T and Verizon have had to postpone their activation of 5G masts and cables because of concerns regarding the safety of air traffic in and around airports. Therefore, an Indo-Pacific digital trade agreement would be the corollary of the ongoing efforts in the EU-US Trade and Technology Council to harmonise technology and data sharing rules and standards across the Atlantic, with the aim of fostering greater competition and easier access for investment, products and services. There is also now greater support in the US Congress for its ratification of the UN Convention on the Law of the Sea (UNCLOS), which was once rejected because of worries about constraints on US sovereignty. Today, by contrast, some US politicians, like US Representative Bera, believe that ratification would put Washington in a stronger position in contesting Chinese claims in the South China and East China Seas. The mantra here is ‘competition without conflict’.

Finally, a discussion is underway about how to combine the administration’s ‘Build Back Better World’ initiative to invest in infrastructure, transport links, agriculture and telecommunications with the EU Commission’s proposal for a ‘Global Gateway’. Synergy between these two programmes and international financial institutions, such as the World Bank and its International Finance Corporation arm, will be required to avoid duplication and to offer developing countries a viable alternative to China’s Belt and Road Initiative.

The aim of all these measures is to give the world a choice, both by reducing dependency on Chinese investments, products and services, market access and consumers, as well as by developing toolboxes of anti-coercion instruments. It is a choice between the liberal democratic way of doing business, albeit not perfect but at least governed by rules, standards, transparency and internationally accepted dispute resolution mechanisms, and the Chinese model, offering profits, capital and wealth, but in lieu of the rule of law and subject to the whims of Chinese leadership.

The aim of anti-coercion instruments and the reduction of supply chain vulnerabilities is not to totally decouple the globalised economy into two rivalling systems with two separate internets. AI and data are two separate legal regimes for trade, financial flows and investment. That decoupling might make us safer, at least in the short term, but it would make us all considerably poorer. Global recovery from the COVID-19 crisis and the restoration of global supply chains that are currently driving inflation need a buoyant Chinese economy that is open for business. So, the challenge for the West is to use its own economic statecraft to protect its economic interests and autonomy, while persuading Beijing that its interest lies in adhering to the rules based international trading order. This will also require a serious Western effort to engage Beijing in a modernised WTO.

The way to achieve this is by demonstrating to China that economic nationalism generates costs out of all proportion to the benefits. It is far too early to do a stocktake of the US-EU strategy. Many of the anti-coercion measures or supply chain reshoring laws and directives have not even passed through the legislatures yet. As Winston Churchill is often attributed with saying: “however beautiful the strategy, you should occasionally look at the results.” We will take this advice and look at the results, but only once the jury is in.