War by other means
Trade tensions continue to build. The US trade team left Beijing empty-handed last week after arriving with a remarkable list of demands, with which it would be impossible to comply. China unsurprisingly responded in turn. This is another chapter in the ill-judged Trump Administration approach to trade policy. There are real issues with respect to China’s trade and economic policy, but the US approach is unlikely to be effective.
Indeed, relations with likely partners in engaging on China – the EU and Japan – are being undermined by the ongoing tariff actions. The EU was given a month’s reprieve on tariffs, but commendably shows no sign of buckling. However, Japan was hit by the steel tariffs, despite Mr Abe’s personal diplomacy with Mr Trump (as was New Zealand, hardly a strategic threat to the US steel industry).
These actions are undermining the rules-based foundations of the international trading system, in ways that will have enduring effects. Among other things, this is reinforcing the increasingly discretionary use of economic and trade instruments. I have previously described the weaponisation of international trade, citing examples including Chinese restrictions on Norwegian salmon imports and on South Korean tourism (and South Korean firms like Lotte and Hyundai) after bilateral political disputes; the sanctions imposed on Qatar by Saudi Arabia and the UAE; and the impact of Russian sanctions and counter-sanctions from 2014 (exports to Russia from the Nordics and Baltics remain 30-50% lower than before the sanctions).
These sanctions can be effective, although variably so. The increasingly tight economic restrictions being imposed on North Korea by China, for example, are likely a significant factor in driving North Korea’s change of approach. Chinese imports from North Korea slumped to just US$9m in February and $12m in March, down from a monthly average of around $100m over the past few years (a reduction of almost 90%).
But recent unilateral actions, notably by the Trump Administration, take the use of sanctions into relatively uncharted territory. First, the US sanctions on firms linked to Putin-linked Russian oligarchs. The global operations of firms linked to Oleg Deripaska (aluminium producer Rusal and related firm EN+) were hit by sweeping sanctions, despite limited direct exposure to the US, which means that trading houses, banks, and others cannot deal with them. The share prices in Rusal and EN+ were down by over 50%. Discussions with the US Treasury are underway to figure out which governance changes at these firms will be satisfactory to have the sanctions removed.
This specific targeting was also seen in the US sanctions imposed on Chinese technology firm ZTE, one of the world’s largest telecom equipment firms. The US Commerce Department imposed a seven year ban on buying US components because of alleged violations of trade sanctions on Iran and North Korea. Its shares have been suspended from trading, and its commercial future is in doubt.
And this week, Mr Trump announced that the US would unilaterally pull out of the nuclear deal with Iran, deciding to re-impose sanctions on Iran – as well as to impose secondary sanctions on firms from other countries that do business with Iran. Non-US firms with US operations, or that are banked by institutions that have a US presence, will be greatly constrained in doing business with Iran. This is a particular exposure for European firms, unless EU officials are successful in securing exemptions. As the newly-installed US Ambassador to Germany bluntly tweeted ‘US sanctions will target critical sectors of Iran's economy. German companies doing business in Iran should wind down operations immediately’.
Unsurprisingly perhaps, this US action will have a limited impact on US firms relative to its partners. US exports of good to Iran were just US$150m in the year to February, whereas the combined exports of goods to Iran from France, Germany and Italy were about US$7b. China may be a winner from this: it currently exports about US$16b to Iran, and takes about 15% of Iran’s oil production.
In response, French Finance Minister Bruno Le Maire noted on Wednesday that ‘The international reach of US sanctions makes the US the economic policeman of the planet, and that is not acceptable’. At a time when the US seems less interested in remaining the world’s reserve currency issuer, these sanctions are perhaps the new version of the ‘exorbitant privilege’ that Valery Giscard d’Estaing, a predecessor as French Finance Minister, warned of in the 1960s. The centrality of the USD in the global system gives the US options that other countries don’t have.
Economic sanctions are preferable to military conflict, and there is justification for sanctions in some cases. But the unilateral application of these measures risks further fragmentation of the international system when it is already stressed by protectionism and mercantilism. Economic instruments are increasingly being used in a unilateral, extra-territorial way by large powers, particularly the US and China, to advance geopolitical and strategic interests. Firms from competitor countries are increasingly being targeted, outside the constraints of a rules-based system.
This may accelerate the movement towards a fragmented economic system, in which China and Russia increasingly engage with each other, and Europe and the US drift apart. Some countries may weigh the costs and benefits of transacting in USD or with US banks if that creates exposure to unilateral US sanctions. And similarly, these large country behaviours may cause firms to think hard about their global footprint. What starts with specific, targeted sanctions may lead to structural change in the functioning of the global system, and the emergence of a multipolar global economy.
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