An Overview of Economic Security (4): Economic Statecraft for Economic Security

The Current State of Global Power Competition

Currently, the world is facing the most intense period of power competition since the end of the Cold War—or perhaps even World War II. Both Russia and China have expressed a desire to challenge the international order led by the G7, and both have the capacity to do so in different ways. China is almost a peer competitor to the United States in economic, military, and technological dimensions. While Russia does not have the same strategic weight, it is willing to take more risks because its leadership feels more deeply aggrieved and it still has systemic relevance in nuclear weapons and fossil fuel energy. Both countries are motivated by a shared feeling that the West—the G7 in general and the U.S. in particular—are in structural decline due to political dysfunction, social cleavages, and fiscal profligacy.

Since great powers are also nuclear powers, there is a mutual deterrent against kinetic conflict and therefore, conflict will take place in the economic and technological realms. Given this background, we can assume that sanctions and related tools such as export controls, tariffs, price caps, and investment restrictions will be used with greater frequency and potency than ever before. In the case of Russia, we can observe that the employed sanctions are working effectively in a strategic sense from a short-, medium-, and long-term perspective, including in the goal of creating leverage to come to a diplomatic end to the war.

The unity that has been forged, both within the G7 and beyond, within hours of the Russian invasion of Ukraine is something to be proud of. However, two-thirds of the world's population live in countries that have not joined the sanctions coalition due to concerns about the efficacy and legitimacy of the sanctions. These concerns deserve our utmost attention both because the merits of the actions are important, and because the size of any coalition is also important. If this skepticism is left unaddressed, it will erode our credibility, hurt our soft power, and degrade our capacity to attract countries into our geopolitical orbit.

A Doctrine for Economic Statecraft

First of all, what can be done is articulating a doctrine of economic statecraft at the highest levels of government, defining the rules governing this realm of action. While crafting and refining military doctrine has a long tradition, efforts to lay down a doctrine of economic statecraft have just begun. A doctrine would both prevent and constrain overreach of these tools and provide assurance to the rest of the world that these weapons are not being used arbitrarily or capriciously. A doctrine would lay down guiding principles, which should be debated and deliberated within government and across governments.

In general, these tools of economic statecraft should only be utilized when core international principles that underpin peace and security are at risk. They should not be used to create commercial advantage and unnecessary spillovers to the target’s civilian population or third countries. They should also be calibrated to maximize the chance of coordination among like-minded partners. Flexibility and sustainability are also essential. Furthermore, to justify the economic costs and risks involved, the principles must pass a threshold of efficacy, ensuring that the impact on the target and the influence on the target’s behavior has to be sufficient to justify the costs of such measures. Most importantly, their design and execution must be infused with a sense of humility. Sanctions and statecraft involve breaking bonds in the global economy through trade, capital, and technology, because mistakes are inevitable in this type of endeavor. Humility, on the other hand, ensures the willingness to change one’s mind, make course corrections, and admit when you are wrong.

In addition to guiding principles, rules of engagement need to be established for all parties involved to limit why, when, how, and against whom these tools are used, meaning that the geopolitical objectives, the timing of deployment, the acceptable and unacceptable goals for sanctions etc., the circumstances under which unilateral action is possible, and ensuring the difference between applying such tools to private individuals and companies vs. technocrats, government officials, military personnel and political leadership must all be clear, respectively. Finally, the last element of doctrine to consider is a code of conduct for practitioners of economic statecraft. Just like military personnel, they should commit to an oath that upholds the standards of behavior outlined in the principles and the rules of engagement for the sake of credibility.

The Importance of Analytical Infrastructure

In addition to formulating a doctrine, upgrading the analytical infrastructure that executes sanctions and statecraft by taking a regular inventory of the growing list of tools of economic statecraft is crucial. Government authorities should also assess the efficacy of these tools under different circumstances and analyze their historical spillovers and limitations to document lessons learned. The use of these tools should also be simulated by stress testing them in multi-stage, multiplayer, long-term conflict scenarios, evolving into a continuous process that helps to identify where tools, defense mechanisms, and forms of coordination need to be strengthened or newly invented. Additionally, analysis of possible evasion needs to be conducted before deploying sanctions in order to be able to flexibly respond in real time if evasion occurs.

The most critical element is personnel. A diverse army of technocrats with multidisciplinary expertise—extending across macroeconomics, microeconomics of critical supply chains, trade finance, financial forensics, diplomacy, international law, and domestic law—is needed. To be able to swiftly coordinate and execute in a crucible moment, the team needs to be large enough to have enough absorption capacity to handle multiple crises at once and have connections with allies, partners, the regulatory community, the private sector, and key stakeholders that multiply the impact of sanctions.

Economic Statecraft for Mutual Economic Gain

Lastly, striking a more deliberate balance in the conduct of economic statecraft is what will matter most to the rest of the world. Instead of feeding a perception that the focus of economic statecraft is on breaking linkages in the global economy and imposing economic pain, we need to convey a standing preference for economic tools that attract countries into our geopolitical orbit through the prospect of mutual economic gain. Examples of such tools include debt relief, concessional lending and infrastructure finance, supply chain partnerships, and technology alliances.

This is especially relevant when discussing the intensifying tensions with China, which represents a different kind of challenge than Russia. With Russia, there were multiple areas of asymmetric advantage that the West and the G7 used strategically. China has far more formidable defensive buffers and higher potential to go on the economic offensive by exploiting choke points in critical supply chains like clean energy or pharmaceuticals, or by taking advantage of its unrivaled scale in the production of manufactured goods. Therefore, the challenge is significantly greater.

This does not mean that sanctions cannot be employed in a conflict scenario with China. No country is too big to sanction. However, coercive measures alone cannot produce a knockout blow in a full-fledged economic confrontation with China without severe collateral damage. Therefore, right now, before a conflict scenario enfolds, we must find ways to utilize the positive tools of economic statecraft to attract a larger coalition that goes beyond the G7.

Comments and Q&A

HIRAI Hirohide:
The decline of activity in the Russian economy, paired with embargoes from G7 countries, has contributed to the decline of the Russian military’s capacity for their war, although it may not have been as effective as expected. We must analyze the efficacy of the sanction measures. Is there any written document that outlines those measures and their ultimate goals?

Daleep SINGH:
To my knowledge, there is not yet a document in the public domain about the efficacy of those measures, but it is necessary to have such a document for accountability and credibility. The depth of the recession was accomplished by three policy choices in Russia, namely capital controls (which are a form of self-isolation, hurting its imports and modernization efforts), weaponizing energy supply (which lost his G7 customer forever), and ramping up government spending which created a wartime economy (this will increase inflation, interest rates and eliminated private sector borrowing and lending). All of this has accelerated inflation and interest rates. In the long run, the sanctions effort will have made Russia a smaller, weaker, more isolated economy. This is the tragic choice that Putin has made, and he alone is responsible.

HIRAI Hirohide:
Is the objective of the doctrine that you mentioned first to understand the main objectives of those measures and then analyze their merits, demerits, and efficacy? Additionally, should we examine issues periodically to use them as lessons to understand the future of those conflicts?

Daleep SINGH:
It is vital to be precise in articulating the strategic objectives of these sanctions. In the case of Russia, there were three objectives: maximizing the costs on Putin for continuing the war, degrade his capacity to exert influence, and creating a negative demonstration effect for other autocrats.

Five channels were laid out to accomplish those strategic objectives. One was to deliver a capital account shock to the Russian financial sector by blocking the largest Russian banks and its central bank from any transactions with G7 economies. Another was to cut off Russia from cutting-edge technology that would modernize their military industrial complex. Downgrading Russia's status as a leading energy supplier to minimize export revenues, methodically removing Russia as a full participant in the international economic order, and seizing physical assets accumulated by Putin and his cronies to expose the kleptocracy and undermine Putin’s narrative domestically were the other three channels used.

To what degree have those channels achieved their strategic objectives? This analysis is difficult to perform because sanctions serve only as a complementary measure. They were never intended as a standalone measure to win this war, but to provide support and diplomatic leverage. The most important effort was to support Ukraine's fight for freedom on the battlefield. We have to wait before we can judge whether the sanctions had the intended effect.

HIRAI Hirohide:
We need to understand the expected time frames for the outcomes of sanctions. Prolonged sanction periods seem to lead to larger collateral damage on the parties imposing the sanctions. For example, we are already witnessing members of many ruling parties in Western countries losing elections because of inflation, so the timing for evaluating the efficacy of the sanctions is very important.

Daleep SINGH:
This relates to the rationale for having principles that guide the design of sanctions before their implementation. In this conflict there was no doctrine in place, but it will be relevant for the next time. For the sake of transparency and accountability, we should articulate that sanctions meet our outlined principles. The analysis performed before deploying sanctions must be weighed against the alternative of not using sanctions. What would be the costs of doing nothing? Do we just stand by and let aggressors do what they wish, violating the principles that have kept international order for 70 years?

HIRAI Hirohide:
You suggested greater cooperation and economic engagement with the countries in the Global South which were negatively impacted by the price hike on crude oil, gas, and coal triggered by the sanctions on the Russian energy sector. What could be a starting point to gain more consensus from the Global South?

Daleep SINGH:
The debt distress that 60 percent of low-income countries currently face, according to the International Monetary Fund (IMF), is a massive problem that needs to be solved. The pandemic, the spike in prices after Russia’s invasion of Ukraine, and climate change measures have contributed to this issue and yet, at the moment, the largest bilateral creditor to low-income countries is China and not the G7.

The G20 announced a common framework to restructure debt in a consistent and orderly way, but that framework has neither been commonly shared nor implemented. I would propose a grand bargain that the G7 countries could spearhead. If China is unwilling to restructure the debt to these countries on comparable terms to those that G7 countries and the Paris Club are willing to offer, we could suggest that these countries walk away from debt obligations above a certain threshold of debt service.

Additionally, the G7 should request that the IMF lend to countries that are in arrears to another government, as was done for Ukraine in 2015. Subsequently, the G7 would need to backfill for the financing that those countries used to receive from China by employing positive tools of economic statecraft to provide an alternative. Attractive debt, equity and infrastructure financing, supply chain partnerships and new sources of funds must all be offered by G7 countries. Finally, multilateral development banks (MDBs), especially the World Bank, need to be involved as well by taking on more risk in their lending, to deal with the debt crisis. Taking these steps would be a credible signal to many countries that have expressed skepticism about the use of sanctions that the sanctioning countries are also delivering solutions to present problems.

HIRAI Hirohide:
How can a heightened sense of needing to support the Global South be reconciled with concerns about human rights?

Daleep SINGH:
Compromising on human rights is never an option. High standards for the impact on the local labor market are needed and financing projects that use child labor, cause environmental damage, or put the human rights of a local population at risk are out of the question.

However, finding creative solutions to solve issues surrounding financing is necessary especially in response to recipient countries’ complaint that G7 financing is expensive, slow, and small. One example of self-critique regarding the U.S. would be related to sovereign loan guarantees, which are a concessional lending instrument that is beneficial for the borrower. This tool has only been used in 6 cases and its use could be greatly expanded, alongside other options. The U.S. could have a sovereign wealth fund to make efficient long-term strategic investments in other countries, which can be achieved by refining and strengthening existing tools and creating new ones. Just as much effort should be invested on these positive instruments as in the design of sanctions and other punitive measures.

HIRAI Hirohide:
Regarding export controls, one issue is that third countries can be exploited as a loophole for Russia etc. to import products and services. How can the effectiveness of future export control be improved? Should we focus more on “running faster” rather than blocking, especially in the case of China?

Daleep SINGH:
The most important step we can take is of course running faster by investing in our own capacity to innovate and develop foundational technologies. On the other hand, whenever there is conflict, the control of foundational technologies that can be applied to a rogue country’s military is crucial. There have indeed been efforts to evade sanctions through third countries and this needs to be prevented.

First, foundational technologies that are central to the sophistication of a military industrial complex need to be identified. In addition, anticipating where the evasion will occur through analysis by multidisciplinary experts is crucial to be able to react in a timely and flexible manner.

HIRAI Hirohide:
The U.S. administration claims that the restrictions for export control of those sensitive sectors are “a small yard with a high fence.” However, there is an increasing number of products and services that are unrestricted, and focusing on the change of technological development is necessary. Smaller yards may become bigger, with higher fences. Is that the default scenario to expect in the future?

Daleep SINGH:
Along with changes in technology, the dimensions are going to change over time as well. We must keep in mind why we need these export controls. In the case of China, it is the result of two of Beijing’s policy decisions, namely military-civil fusion and the “Made in China 2025” initiative, which is a very aggressive, mercantilist stance. The most important thing we can do is to develop technologies, but we also have to limit their diffusion. Change of the dimensions is inevitable in this environment, which means that the width of the yard and the height of the fence will likely grow.

HIRAI Hirohide:
That is the message that observers, especially businesspeople, need to recognize.

Daleep SINGH:
We owe the business community and our citizens a doctrine and an analytical process that takes these tools seriously. The long-term efficacy of using export controls needs to be considered. Will we be better off ten years from now if we use these tools? This type of efficacy analysis is the work we have before us.

HIRAI Hirohide:
You mentioned the importance of personnel as a specific issue in the U.S. Perhaps a better analysis could be achieved through international cooperation? How can broader international cooperation in terms of analytical work among G7 countries and like-minded countries be fostered?

Daleep SINGH:
In a sense, the U.S. needs to follow Japan's lead. Japan has been at the forefront of developing a team that is focused on economic security as laid out in its national security strategy.

We need to establish a similar team—both within the G7 and beyond—to identify contact persons and examine each tool for economic statecraft by simulating conflict scenarios and getting experts of each field involved. We need to arrive at a common understanding of the likely effects, impact, benefits, and costs before we deploy these tools. Even if there is no agreement on the analysis, at least we will understand each other and our respective vulnerabilities.

FUKUOKA Noriyoshi:
As you mentioned, collective action among the G7 and the involvement of the Global South are very important. What kind of international framework would be effective to achieve this? Perhaps the Indo-Pacific Economic Framework (IPEF)?

Daleep SINGH:
The current U.S. Secretary of State, Antony Blinken, often says that we are in an environment where we need to have variable geometry, a phrase that may be relevant to this question. The coalition that we can build depends on the type of positive cooperation that is available.

For example, we can imagine a particular kind of coalition around critical minerals: the G7 countries, the DRC, and perhaps Argentina, Bolivia, Chile, and Australia. For semiconductors, a coalition could involve Korea, Taiwan, Japan, the U.S., and the Netherlands, among other countries. For debt relief, it would be the Paris Club and other creditor countries. Ultimately, we would have to involve China as well.

Therefore, there is more than one possible grouping. The G20, the IPEF, or the UN would be the place for this to happen, but that is the world as it should be, not the world as it is.