Values and the Role of Sanctions in the Europe-China-US Triangle

Today, the immediate question is not a life-or-death issue, but a more modest one of economic choices. Both consumers and companies crave China, either for its products or for profits from its domestic market. The combination creates nearly total indifference to a huge EU trade deficit, which is only noted with respect to job losses. These are difficult to measure and to distinguish from the overall effects of productivity gains and globalization. Our thirst for competitively priced products and the legitimate interests of our companies in the Chinese market therefore generate vulnerabilities. In the trade conflict initiated in 2017 between the United States and China, rising prices for US consumers have been debated more often than the impact on Chinese producers and exporters (who did suffer losses, although in the aggregate these were compensated elsewhere, notably with the EU). 

This dilemma also hardly existed with the Soviet Union, a poor Leninist state, and it exists only for limited constituencies with Russia, a small economy that is only significant for energy and minerals. Politically and economically, China poses a challenge which can be compared with the perils from Europe’s early 1930s or from the Far East of the same era, more than with those from the Soviet Union and Cold War era. Europe in the 1930s was already very interdependent in economic terms, while the Great Depression divided democracies inside and among themselves. In the Far East, Imperial Japan’s extreme nationalism coincided with a fear of sanctions or blockades that could limit its access to global resources. This created Japan’s own preference for a security-driven self-sufficiency and a disastrous preemptive lunge into the Pacific. We have an echo of this with China’s new "dual circulation" economic strategy, and the construction of the world’s largest navy by numbers. Decoupling can become a self-fulfilling prophecy, and preemptive moves create counter moves from abroad.

It is in this context that Western efforts to link human rights issues with overall relations should be viewed. Following similar US legislation, the European Union has adopted in December 2020 a guidance for a "restrictive measures (sanctions) regime to address serious human rights violations and abuses". Pointedly, these do not include sectoral/trade bans, nor do they have much extraterritorial effect, in the sense that only EU operators are bound to implement them. Often dubbed Europe’s Magnitsky Act, this is obviously a weaker regime than the panoply available to the US government. Still, this is a concrete linkage between values and interests, an association that the EU also claims to have achieved in its negotiations with China over a Comprehensive Agreement on Investment (CAI). Japan is also currently considering legislation similar to the EU over human rights abuse: nearly a first, although Japan briefly participated in the G7 sanctions against China in 1989 and occasionally sanctioned the Burmese military junta in the 1990s.

China’s retaliation toolbox against sanctions

While the EU has adopted limited and targeted sanctions against four regional cadres over the issue of repression in Xinjiang, China has responded with wider and loosely justified sanctions against European institutions and individuals.

Separately, a boycott against H&M, a Swedish company that had vowed not to source Xinjiang cotton has sprung up, from a thinly veiled government top-down initiative. Clearly, official countersanctions against European companies would not work well for China in its overall economic relationship with the EU, given that China had a €181 billion trade surplus with the EU-27 in 2020.

But a semi-informal boycott applies well to companies that depend on China as an important market: China therefore has a lot of room to go for company-targeted sanctions. This is not the case of H&M, as China only represents around 5% of its global sales. H&M will pull through in any case, and Sweden is not a big EU member state. The present test is intended to have a "chilling effect", while not grave enough to trigger a massive reaction. Footwear and apparel companies that produce and sell in China are on notice that they should not implement American or European sanctions.

Companies are therefore likely to be taken hostage in a political tussle between Xi Jinping’s defiant regime and critical democracies. Mr. Xi himself has asked Starbucks to "play an active role in promoting US-China trade cooperation and bilateral ties" in the context of the new Biden administration. Starbucks has nearly 5,000 stores in China and aims for 6,000 by 2022. How difficult would it be to shutter them or to entice a consumer boycott? When in Berlin in 2014 and addressing Mrs. Merkel, Mr. Xi compared Sino-German relations to driving a car, "look far ahead to run safely and without hitches": as a matter of fact, the German auto industry, so present in China, is under a geopolitical threat. China promotes win-win interdependence. But on the flip side, it can sanction foreign companies in a context of increased self-sufficiency.

From this, it is clear that sanctioning China or moving against one of its state-backed interests is not going to be cost-free. However, the stronger a partner of China is, the more immune its companies may be to sanctions: throughout the trade conflict since 2017, China studiously refrained from sanctioning major US companies (major US internet platforms had already been barred, as China rejects foreign platforms to preserve its "Internet sovereignty"). It is debatable whether American agricultural exporters really suffered, but their Canadian colleagues, as well as Australia, have indeed seen sudden stops in some Chinese crop purchases. Norway - not an EU member state - saw its salmon sales to China take a hit after the attribution of the Nobel Peace Prize to Liu Xiaobo, Chinese dissident and human rights activist. European countries or firms have been occasionally threatened (a direct threat of denying medical supplies to the Netherlands, thinly veiled threats against German auto industry) but rarely hit. The H&M case presents a new situation: a similar movement had seemed to start for Carrefour in 1998, but quickly stopped. In other words, China has in the recent past been more willing to initiate sanctions that affect constituencies with some electoral influence rather than major go after investors in China.

The test is also intended for the rest of the world besides the West - from China’s neighbors which have to weigh economic integration vs. geopolitical risks from China, to developing economies where necessity prevails. Towards Europeans, during a recent call from Angela Merkel, Xi Jinping reportedly asked Europe to "truly achieve strategic autonomy". In a harsher tone, Chinese minister of Foreign affairs Wang Yi is now on the record for warning Japan to "not get involved in the so-called confrontation between major countries" and to refrain from interference over Xinjiang and Hong Kong.

In the case of developing or emerging economies, a recent study examined the terms of 100 international loans offered by the China Development Bank (CDB): it found that fully half of these contracts include wide-open language allowing the CDB to request immediate repayment in case of adverse action against "a PRC entity".

Elsewhere, while China has consistently been a larger public lender than the West and traditional financial institutions, it has sought real leverage and sanction potential. The terms of public loans from China clearly indicate that capacity. Canada and Australia, which are large energy and raw mineral exporters and therefore dependent on China trade, as well as being major destinations for Chinese capital flows, fall in between these categories. Turning on or off Chinese tourism, through the management of "approved destinations" and control of tour operators, has also been used extensively prior to the Covid pandemic.

Even more broadly, China has introduced a legislation for countersanctions, dubbed by some China’s blocking statute, in reference to formally similar EU legislation. The law creates a State Council "working mechanism", an obligation for all Chinese firms to report any harm from "foreign legislation or other measures". These are then examined by the Chinese government to assess whether they constitute "a violation of principles of international relations," or harm China’s "national sovereignty, security and development interests," or the "legitimate rights and interests" of Chinese persons and entities. The review may also include "other factors that shall be taken into account", a habitual clause in PRC law. It specifically excludes, however, measures taken under international institutions or treaties to which China is a party.

Ironically, the model for these is the EU’s own "blocking statute", adopted in 1996, largely as a response to US legislation with extraterritorial effect, and often focused on the case of Iran-related sanctions. The EU’s statute has often been judged ineffective, largely because the support that Europe would give its companies simply cannot equal their reliance on American markets, sourcing and finance. But the terms of application of China’s statute are open-ended, especially as they refer to China’s national security law. They are also completely silent about the actual countermeasures that might be decided. China has created its own Unreliable Entity List to sanction companies implementing re-export denials by other governments, and another law creating its own export controls.

Considering open-ended countersanctions is only one aspect of China’s response.

This is not only achieved through Soviet-type united fronts and the use of fellow-travelers, or with social media and propaganda hammering. China is now setting up extraterritorial tools and a system of coercion and threats. These are derived from China’s national security law to apply to non-Chinese individuals and entities based outside China. They have now been used against ten individuals, including members of the European Parliament and member states parliaments, and one think-tank. Similar sanctions have been announced in the case of the United Kingdom, and earlier in 2020 against top American government officials, as well as two Danish parliamentarians. Remarkably, the sanctions include families and entities in which the individuals have an interest. These measures seek to silence democratic societies, or failing that to isolate elements who criticize China from mainstream opinion and economic interests.

Europe’s dilemma

Two recent policy papers from European sources have approached the theme of sanctions and extraterritorial legislation. Coming from different backgrounds, the two share some common traits: they are almost exclusively defensive, and they do not mention human rights issues. To its credit, ECFR’s note gives as much prominence to China’s economic sanctions or threats as to the US use of extraterritorial legislation. The Jacques Delors Institute note, by contrast, largely concerns the US, and what it calls "political sanctions". It goes as far as to propose visa denials and seizure of assets. It targets what it calls "unilateral action", but it does not say if the requirement for approval would be mutual coordination among, for example, the EU and the US, or multilateral criteria such as endorsement by the United Nations or World Trade Organization.

Nor does the ECFR note consider these last options. But there is a good reason for this. It takes protracted negotiations to pass sanctions at the United Nations against any state, let alone one that is more or less in proximity with China and/or Russia. Any sanction process at the United Nations against China has zero chance of being ever passed, given its right of veto. Any reform of WTO that would include criteria for sanctions over human rights has zero chance of being adopted, given a requirement for unanimous adoption. The difficulties over ensuring the enforcement of sustainable development goals that are in principle widely shared are a good indication of this. One can wish that the international system be otherwise, but this is the reality that we are dealing with.

The debate on the usefulness and success of sanctions is never closed. In any case, a sanction process that has a limited extraterritorial effect - in short, binding only on European Union individuals and companies - will also only have a limited and possibly self-defeating effect. This limited impact applies more to the European Union than to the United States, because the EU monetary and financial system is more easily avoidable than the US dollar and US-based financial system. One can always dream of a more active global role for the Euro, but that is contingent on a deepening of European integration that is far beyond the present issues. Rightly, the ECFR notes the efficiency and thoroughness of the US Treasury in identifying and sanctioning third parties who flaunt a sanctions regime. An EU Treasury is what does not exist, a direct consequence to the lack of a significant European budget and tax system. Among propositions from this note, there is "a public EU bank to keep payment channels open with third countries sanctioned by great powers". Over Iran, small-scale attempts in this direction have immediately failed, largely because companies cannot avoid US-based financial circuits. One should note, however, that since the Renminbi has only a 2.4% share of global transactions, a stopgap financing institution would be more efficient in countering Chinese sanctions against third parties. One should also note that direct US financial sanctions, which have been applied to cases like North Korea or Sudan, are limited to individuals in the case of China. Beyond the obvious stakes for US banks and financial funds, there may be a strategic reluctance to financially decouple from China. This does not rest on the hackneyed risk of a Chinese dumping of US Treasury bonds, as China’s purchases are neither dominant nor irreplaceable. Rather, there is a strategic advantage in preserving both China’s anchor to the dollar, and financial denial as an ultimate deterrent. Financial sanctions against Chinese entities are the dog that has not barked, even as export controls and technology denials are being introduced.

Limiting the extraterritorial reach of European sanctions to European entities’ dealings with sanctioned parties will also be self-defeating. It would penalize European companies even more deeply, as they would have to exclude themselves from dealing with sanctioned entities in third markets while their competitors could take their place without any consequence from the European Union. In the past decades - on Iran, Sudan, North Korea, Myanmar, and even in Europe where Russian entities have been placed under sanction - this has benefitted first of all China and Chinese companies, which have systematically expanded their share of markets placed under sanctions. To the extent that these companies avoided the American financial system, they also evaded US sanctions: this is why the Huawei case is so significant, because the American prosecution relied on the company’s disguised use of American financial networks to finance one of its subsidiaries sales to Iran. Tomorrow, the problem will be even more acute: whether on export controls and technology denials or on formal sanctions, China can leverage its own market by favoring companies that do not follow sanctions, while punishing those which do.

From this follows a profound European dilemma. Combining the present goals of the existing EU "restrictive measures" with the recommendations of one or the other policy note cited above, Europe must:

1. Deter the United States from adopting extraterritorial sanctions that non-American third parties are obligated to follow. 
2. Preserve its own "restrictive measures" over values, formalized in December 2020, which have a limited extraterritorial reach that only applies to EU actors. Some of these are now in place against several countries including China.
3. Face China that grants itself a free and unlimited use of sanctions, which seems in effect to grow along with the economic dependence of its partners. 

Like economist Robert Mundell’s famous triangle, these three goals cannot be fulfilled at the same time. One must choose. In fact, two of these goals have to be conceded in most cases.

1. Giving up goal n°1 enables Europe, in coordination with the United States, to face China’s unlimited range of countersanctions while maintaining a modest and largely symbolic range of its own measures. 
2. Giving up goal n°2 frees Europe to counter US extraterritorial sanctions. This makes goal n°3 pointless, since China, even if it opposes limited European sanctions, must appreciate Europe’s opposition to the United States. However, Europe must hope that China will not leverage Europe further. Europe will have to abandon all offensive tools to advance the values that it professes.
3. Giving up goal n°3 enables Europe to face US extraterritorial sanctions. In practice, it also excludes goal n°2, as China would certainly counter this in confidence if transatlantic division were ensured.

Obviously, this remains a logical and abstract framework. Coordination of goals with the new US administration may reduce the dilemma. Although an exit from China’s present policy trends cannot be anticipated, the country has changed course several times since 1949. Strengthening of the European Union itself is a mid- to long-term process with political uncertainties. But this has also happened several times since 1958, and it can change the terms of Europe’s sanction dilemma. One should note, however, that the present issues of innovation, research & development and industrial policy go beyond the scale of what the European Union has achieved in the past. They require deeper European integration, and while this condition is necessary, it is still not sufficient.

What is sure is that strategic autonomy is a distant goal. Placing measures against US extraterritorial sanctions first on the "to-do" list is akin to putting the cart before the horse. Of the three choices presented above, it is the first that, for an unpredictable amount of time, represents Europe’s best option while building its own capacities. On the interest front, the US still represents a much greater stake for most, if not almost all, European companies. On the value front, if one understands the alarm at some of the directions taken by the former US president, many if not all signs point to a new operating system for this administration, neither continuing the Trump presidency nor reverting to the Obama era. True, nothing is assured forever and the continuity of purpose of any US administration is not guaranteed. But isn’t that the case for every democracy, and should that lead us to policies adopted by default? 

Copyright: NOEL CELIS / AFP